Internal Presentation | Tree-implied crash probability & Understanding Crude Oil Risk in China: The Role of a Model-Free Volatility Index

Title 1: Tree-implied crash probability

Abstract: We develop a generalized binomial tree model with jumps to extract a forward-looking risk measure: the tree-implied crash probability (TCP). Unlike traditional models that treat trees as discretizations of continuous-time processes, our standalone lattice framework endogenously identifies the market’s perceived jump skewness from option prices. We find that TCP is a robust predictor of the equity risk premium across horizons of 1 to 24 months, delivering significant out-of-sample gains that outperform a comprehensive suite of state-of-the-art predictors. Beyond serving as a proxy for systemic risk, TCP is uniquely linked to the order imbalances of sophisticated option traders, suggesting that it captures an informed trading channel omitted by standard volatility indices.

Title 2: Understanding Crude Oil Risk in China: The Role of a Model-Free Volatility Index

Abstract: We construct the China Crude Oil Volatility Index (CNOVX)—the first model-free, option-implied measure of forward-looking oil price risk for China using INE crude oil options from 2021 to 2024 and an adapted CBOE methodology that accounts for sparse strike availability via smooth interpolation and extrapolation. Our results show that CNOVX increases with trading activity in the futures market, declines with option volume, and is strongly predicted by the 30-day realized variance of the SC crude oil futures contract. External shocks, including the Russia–Ukraine conflict and the Geopolitical Risk Index, significantly elevate CNOVX levels. During the COVID-19 pandemic, mortality risk intensifies the volatility-amplifying role of futures trading and strengthens the volatility-dampening effect of options, while confirmed case counts have a weaker influence. We further document a pronounced asymmetric leverage effect: negative futures returns raise CNOVX more than positive returns of equal size. However, volatility feedback effects are negligible, as changes in implied volatility respond primarily to contemporaneous market conditions. Overall, CNOVX serves as a timely and informative benchmark for monitoring risk in China’s evolving crude oil derivatives market, with valuable implications for investors, hedgers, and policymakers.