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Forecast performance of implied volatility and the impact of the volatility risk premium

Author

Listed:
  • Ralf Becker

    (Manchester)

  • Adam Clements

    (QUT)

  • Christopher Coleman-Fenn

    (QUT)

Abstract

Forecasting volatility has received a great deal of research attention, with the relative performance of econometric models based on time-series data and option implied volatility forecasts often being considered. While many studies find that implied volatility is the preferred approach, a number of issues remain unresolved. Implied volatilities are risk-neutral forecasts of spot volatility, whereas time-series models are estimated on risk-adjusted or real world data of the underlying. Recently, an intuitive method has been proposed to adjust these risk-neutral forecasts into their risk-adjusted equivalents, possibly improving on their forecast accuracy. By utilising recent econometric advances, this paper considers whether these risk-adjusted forecasts are statistically superior to the unadjusted forecasts, as well as a wide range of model based forecasts. It is found that an unadjusted risk-neutral implied volatility is an inferior forecast. However, after adjusting for the risk premia it is of equal predictive accuracy relative to a number of model based forecasts.

Suggested Citation

  • Ralf Becker & Adam Clements & Christopher Coleman-Fenn, 2009. "Forecast performance of implied volatility and the impact of the volatility risk premium," NCER Working Paper Series 45, National Centre for Econometric Research.
    • Handle: RePEc:qut:auncer:2009_58
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    File URL: http://www.ncer.edu.au/papers/documents/WPNo45.pdf
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    References listed on IDEAS

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    2. Peter Reinhard Hansen & Asger Lunde & James M. Nason, 2003. "Choosing the Best Volatility Models: The Model Confidence Set Approach," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 65(s1), pages 839-861, December.
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    4. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Paul Labys, 2003. "Modeling and Forecasting Realized Volatility," Econometrica, Econometric Society, vol. 71(2), pages 579-625, March.
    5. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
    6. Patton, Andrew J., 2011. "Volatility forecast comparison using imperfect volatility proxies," Journal of Econometrics, Elsevier, vol. 160(1), pages 246-256, January.
    7. Jorion, Philippe, 1995. "Predicting Volatility in the Foreign Exchange Market," Journal of Finance, American Finance Association, vol. 50(2), pages 507-528, June.
    8. Blair, Bevan J. & Poon, Ser-Huang & Taylor, Stephen J., 2001. "Forecasting S&P 100 volatility: the incremental information content of implied volatilities and high-frequency index returns," Journal of Econometrics, Elsevier, vol. 105(1), pages 5-26, November.
    9. Christensen, B. J. & Prabhala, N. R., 1998. "The relation between implied and realized volatility," Journal of Financial Economics, Elsevier, vol. 50(2), pages 125-150, November.
    10. Scott I. White & Adam E. Clements & Stan Hurn, 2004. "Discretised Non-Linear Filtering for Dynamic Latent Variable Models: with Application to Stochastic Volatility," Econometric Society 2004 Australasian Meetings 46, Econometric Society.
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    Cited by:

    1. Wu, Feng & Myers, Robert J. & Guan, Zhengfei & Wang, Zhiguang, 2015. "Risk-adjusted implied volatility and its performance in forecasting realized volatility in corn futures prices," Journal of Empirical Finance, Elsevier, vol. 34(C), pages 260-274.

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    More about this item

    Keywords

    Implied volatility; volatility forecasts; volatility models; volatility risk premium; model confidence sets;
    All these keywords.

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • G00 - Financial Economics - - General - - - General

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