ARE VOLATILITY EXPECTATIONS CHARACTERIZED BY REGIME SHIFTS? EVIDENCE FROM IMPLIED VOLATILITY INDICES

Thus, in order to reduce measurement errors and avoid problems of numerical
convergence, this study uses two indices of implied volatility, namely the new VIX index on
the S&P 500 benchmark disseminated by the Chicago Board of Options Exchange and a
new index similarly computed from Nikkei 225 stock average options traded on Osaka
Securities Exchange. The model-free approach used in estimating these implied volatility
indices takes into account the term structure of implied volatility and possible nonlinearities
such as the volatility smiles. It aggregates information across different options maturities
and exercise prices and expectations about future volatility across market participants
including hedgers, arbitrageurs and speculators.

This study differs from previous studies on several accounts. It provides new
evidence on regime shifts in expectations of stock market volatility implied by options
prices. It allows for the identification of regimes characterized by expectations of lower
volatility and bursts of turbulence, the speed of mean reversion and the length of the
memory process. Furthermore, it tests for the existence of leverage effects in options
markets in the sense that good and bad news from the stock market exert asymmetric effects
on expectations of short-term volatility. It also addresses the important question of whether
the regimes of expected volatility are reflective of a feedback process through which
anticipations of future market volatility adapt to changes in realized volatility. Thus, new
evidence from regime switching models is provided on the relationship between implied
volatility and realized volatility, which is examined using conventional regression analysis.

Furthermore, it provides empirical results from an international perspective as it
uses implied volatility indices for the US and Japanese stock markets. In the absence of
implied volatility benchmark readily available for the Japanese equity market, this study
uses the Nikkei 225 implied volatility index reported in Nishina, Maghrebi and Kim (2006).
The construction of an implied volatility index for the Japanese equity market is important

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