Financial Crises, Implied Volatility and Stress Testing

Oct 1, 2001

This paper surveys the behavior of forward-looking asset prices during market crises, with particular focus on historical and implied volatilities. We focus on two specific episodes, the European monetary crisis of 1992-1993 and the Asian crisis of 1997 to 1999. Implied volatilities are shown to contain useful information for predicting market stress in the immediate future.