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New evidence on the implied-realized volatility relation

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Author Info
Bent Jesper Christensen
Charlotte Strunk Hansen

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Abstract

We consider the relation between the volatility implied in an option's price and the subsequently realized volatility. Earlier studies on stock index options have found biases and inefficiencies in implied volatility as a forecast of future volatility. More recently, Christensen and Prabhala find that implied volatility in at-the-money one-month OEX call options on the S&P 100 index in fact is an unbiased and efficient forecast of ex-post realized index volatility after the 1987 stock market crash. In this paper, the robustness of the unbiasedness and efficiency result is extended to a more recent period covering April 1993 to February 1997. As a new contribution, implied volatility is constructed as a trade weighted average of implied volatilities from both in-the-money and out-of-the-money options and both puts and calls. We run a horse race between implied call, implied put, and historical return volatility. Several robustness checks, including a new simultaneous equation approach, underscore our conclusion, that implied volatility is an efficient forecast of realized return volatility.

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Publisher Info
Article provided by Taylor and Francis Journals in its journal The European Journal of Finance.

Volume (Year): 8 (2002)
Issue (Month): 2 (June)
Pages: 187-205
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Handle: RePEc:taf:eurjfi:v:8:y:2002:i:2:p:187-205

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Related research
Keywords: Index Options; Implied Volatility; Realized Volatility; Volatility Forecasting; Simultaneous Equation Estimation;

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Day, Theodore E. & Lewis, Craig M., 1988. "The behavior of the volatility implicit in the prices of stock index options," Journal of Financial Economics, Elsevier, vol. 22(1), pages 103-122, October. [Downloadable!] (restricted)
  2. Andersen, Torben G. & Bollerslev, Tim & Lange, Steve, 1999. "Forecasting financial market volatility: Sample frequency vis-a-vis forecast horizon," Journal of Empirical Finance, Elsevier, vol. 6(5), pages 457-477, December. [Downloadable!] (restricted)
  3. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179. [Downloadable!] (restricted)
  4. Canina, Linda & Figlewski, Stephen, 1993. "The Informational Content of Implied Volatility," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 6(3), pages 659-81. [Downloadable!] (restricted)
  5. Harvey, Campbell R & Whaley, Robert E, 1991. " S&P 100 Index Option Volatility," Journal of Finance, American Finance Association, vol. 46(4), pages 1251-61, September.
  6. Hausman, Jerry A, 1975. "An Instrumental Variable Approach to Full Information Estimators for Linear and Certain Nonlinear Econometric Models," Econometrica, Econometric Society, vol. 43(4), pages 727-38, July. [Downloadable!] (restricted)
  7. Lamoureux, Christopher G & Lastrapes, William D, 1993. "Forecasting Stock-Return Variance: Toward an Understanding of Stochastic Implied Volatilities," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 6(2), pages 293-326. [Downloadable!] (restricted)
  8. Jorion, Philippe, 1995. " Predicting Volatility in the Foreign Exchange Market," Journal of Finance, American Finance Association, vol. 50(2), pages 507-28, June. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Steven Li & Qianqian Yang, 2009. "The relationship between implied and realized volatility: evidence from the Australian stock index option market," Review of Quantitative Finance and Accounting, Springer, vol. 32(4), pages 405-419, May. [Downloadable!] (restricted)
  2. Peter Carr & Liuren Wu, 2004. "Variance Risk Premia," Finance 0409015, EconWPA. [Downloadable!]
  3. Ayla Ogus, 2002. "Pricing of S&P 100 Index Options Based On Garch Volatility Estimates," Working Papers 0201, Izmir University of Economics. [Downloadable!]
    Other versions:
  4. Cheny Chen & Ming-Hua Liu & Hoa Nguyen, 2007. "The Information Content of Implied Volatility in the Hong Kong and Singapore Covered Warrants Markets," Accounting, Finance, Financial Planning and Insurance Series 2007_16, Deakin University, Faculty of Business and Law, School of Accounting, Economics and Finance. [Downloadable!]
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