Volatility after-effects: evidence from the field

Abstract

Following recent empirical evidence of volatility “after-effects” in the laboratory, we investigate whether investors’ perception of volatility is biased after prolonged exposure to extreme level of volatility. Using VIX as a measure of perceived volatility and daily realised volatility as a measure of actual volatility, we find strong after-effects in the perception of volatility. The effect is stronger, the larger and longer the volatility regime. These results are consistent with both the after-effect theory and the laboratory experiment. Furthermore, we find that the effect is asymmetric due to the absence of sufficiently low volatility regimes in the field. Taken together, these results suggest that investors are subject to perceptual biases that have a significant impact on traded volatility.