Exogenous market changes analysis using artificial options volatility

Abstract This paper focuses on market changes due to exogenous effects. The standard implied volatility is shown to be insufficient for a proper detection and analysis of this type of risk. This is mainly because such changes are usually dominated by endogenous effects coming from a specific trading mechanism or a natural market dynamics. A unique methodological approach based on artificial options that always have a constant (over time) maturity is proposed and explicitly defined. The key principle is to use interpolated volatilities that can effectively eliminate instabilities due to the natural market dynamics while the changes caused by the exogenous causes stay preserved. Formal statistical tests for distinguishing significant effects are proposed under different theoretical and practical scenarios. Statistical theory, computational and algorithmic details, and comprehensive empirical comparisons together with a real data illustration are all presented in the paper.