infonet-economy

This study investigates the efficiency of markets as to the relative pricing of similar risk by using implied volatilities of options on highly correlated indexes and a statistical arbitrage strategy to profit from potential mispricings. It first analyzes the interrelationships over time of the 3 most highly correlated and liquid pairs of US stock indexes. Based on this analysis, the paper derives a relative relationship between implied volatilities for each pair. If this relationship was violated, a relative mispricing was suspected. A simple no-arbitrage barrier was used to identify significant deviations and a statistical arbitrage trade was implemented each time such a deviation was recorded. It was found that, although many deviations can be observed, only some of them are large enough to be exploited profitably in the presence of bid-ask spreads and transaction costs.

http://www.manuel-ammann.com/pdf/PubsAmmann2002VolatilityArbitrageFAJ.pdf