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Volatility puzzles: a unified framework for gauging return-volatility regressions

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Author Info

  • Tim Bollerslev
  • Hao Zhou

Abstract

This paper provides a simple unified framework for assessing the empirical linkages between returns and realized and implied volatilities. First, we show that whereas the volatility feedback effect as measured by the sign of the correlation between contemporaneous return and realized volatility depends importantly on the underlying structural model parameters, the correlation between return and implied volatility is unambiguously positive for all reasonable parameter configurations. Second, the lagged return-volatility asymmetry, or the leverage effect, is always stronger for implied than realized volatility. Third, implied volatilities generally provide downward biased forecasts of subsequent realized volatilities. Our results help explain previous findings reported in the extant empirical literature, and is further corroborated by new estimation results for a sample of monthly returns and implied and realized volatilities for the aggregate S&P market index.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2003-40.

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Date of creation: 2003
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Handle: RePEc:fip:fedgfe:2003-40

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Keywords: Financial markets;

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Citations

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Cited by:
  1. Castrén, Olli & Mazzotta, Stefano, 2005. "Foreign exchange option and returns based correlation forecasts: evaluation and two applications," Working Paper Series 0447, European Central Bank.
  2. Peter Christoffersen & Stefano Mazzotta, 2004. "The Informational Content of Over-the-Counter Currency Options," CIRANO Working Papers 2004s-16, CIRANO.
  3. Hui Guo & Christopher J. Neely & Jason Higbee, 2008. "Foreign Exchange Volatility Is Priced in Equities," Financial Management, Financial Management Association International, vol. 37(4), pages 769-790, December.
  4. Zhang, Xibin & King, Maxwell L., 2008. "Box-Cox stochastic volatility models with heavy-tails and correlated errors," Journal of Empirical Finance, Elsevier, vol. 15(3), pages 549-566, June.
  5. Juan M. Londono, 2011. "The variance risk premium around the world," International Finance Discussion Papers 1035, Board of Governors of the Federal Reserve System (U.S.).

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