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Extrapolation and option-implied kurtosis in volatility forecasting

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  • Pan, Ging-Ginq
  • Shiu, Yung-Ming
  • Wu, Tu-Cheng

Abstract

Prior studies have employed extrapolation to reduce truncation errors when computing risk-neutral moments. However, extrapolation may have a disadvantage in that it obscures the predictive power of risk-neutral skewness and kurtosis. Our out-of-sample results show that extrapolation does not enhance the predictive power of the volatility forecasting models when risk-neutral volatility, skewness, and kurtosis are included. Under this model specification, extrapolation generates less accurate forecasts and obscures the performance of risk-neutral kurtosis in volatility forecasting.

Suggested Citation

  • Pan, Ging-Ginq & Shiu, Yung-Ming & Wu, Tu-Cheng, 2024. "Extrapolation and option-implied kurtosis in volatility forecasting," Pacific-Basin Finance Journal, Elsevier, vol. 84(C).
    • Handle: RePEc:eee:pacfin:v:84:y:2024:i:c:s0927538x24000374
    DOI: 10.1016/j.pacfin.2024.102286
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    More about this item

    Keywords

    Extrapolation; Risk-neutral skewness; Risk-neutral kurtosis; Volatility forecasting;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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