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New Insights on the Implied and Realized Volatility Relation

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  • Lloyd P. Blenman

    ()
    (University of North Carolina-Charlotte, Belk College of Business, Charlotte, NC 28223, USA)

  • Guan Jun Wang

    (Florida A&M University, School of Business and Industry, Tallahassee, FL 32307, USA)

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    Abstract

    Existing studies on the informational content of at-the-money implied volatility (ATMIV) and past realized volatility (PRV) and the relation between the two have mainly focused on a single short forecast horizon and conclude that ATMIV outperforms PRV. We examine the relation between implied and realized volatility over both short and longer forecasting horizons to provide a forecasting competition. We analytically demonstrate the option maturity effect on the sensitivity of the implied volatility (IV) estimation. As time to maturity increases, vega increases but at a decreasing rate, up to $\overline{T}$. At shorter (longer) maturities, small pricing changes should have greater (smaller) corrective impact on IVs. We find that IV outperforms PRV over a one month forecast horizon. However, as the forecast horizon increases, PRV outperforms IV and subsumes the information contained in it. These mixed results may be attributed to the reduced efficiency of longer dated sections of the S&P 500 options index market we analyze.

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    Bibliographic Info

    Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal Review of Pacific Basin Financial Markets and Policies.

    Volume (Year): 15 (2012)
    Issue (Month): 01 ()
    Pages: 1250001-1-1250001-22

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    Handle: RePEc:wsi:rpbfmp:v:15:y:2012:i:01:p:1250001-1-1250001-22

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    Related research

    Keywords: Option; implied volatility; realized volatility; forecasting; informational content; vega;

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