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Bayesian Forecasting of Options Prices: A Natural Framework for Pooling Historical and Implied Volatiltiy Information

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  • Darsinos, T.
  • Satchell, S.E.

Abstract

Bayesian statistical methods are naturally oriented towards pooling in a rigorous way information from separate sources. It has been suggested that both historical and implied volatilities convey information about future volatility. However, typically in the literature implied and return volatility series are fed separately into models to provide rival forecasts of volatility or options prices. We develop a formal Bayesian framework where we can merge the backward looking information as represented in historical daily return data with the forward looking information as represented in implied volatilities of reported options prices. We apply our theory in forecasting the prices of FTSE 100 European Index options. We find that for forecasting options prices out of sample (i.e. one-day ahead) our Bayesian estimators outperform standard forecasts that use implied or historical volatilities. We find no evidence to suggest that standard procedures using implied volatility estimates are redundant in explaining market options prices.

Suggested Citation

  • Darsinos, T. & Satchell, S.E., 2001. "Bayesian Forecasting of Options Prices: A Natural Framework for Pooling Historical and Implied Volatiltiy Information," Cambridge Working Papers in Economics 0116, Faculty of Economics, University of Cambridge.
  • Handle: RePEc:cam:camdae:0116
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    Cited by:

    1. Moritz Duembgen & L. C. G. Rogers, 2014. "Estimate nothing," Quantitative Finance, Taylor & Francis Journals, vol. 14(12), pages 2065-2072, December.

    More about this item

    Keywords

    Bayesian; forecasting; implied volatility; option pricing;

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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