ANALYSIS OF THE TERM STRUCTURE OF IMPLIED VOLATILITIES

From various empirical work, it is well known that the volatility of a sset returns changes over time. This might be one of the reasons that implied volatilities differ for options that only differ in time to ma turity. We construct models for the relation between short- and long-t erm implied volatilities based on three different assumptions of stock return volatility behavior, i.e., mean-reverting, GARCH, and EGARCH m odels. We test these relations on option price data and conclude that EGARCH gives the best description of asset prices and the term structu re of options' implied volatilities.