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New Insights on the Implied and Realized Volatility Relation

Author

Listed:
  • 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)

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.

Suggested Citation

  • Lloyd P. Blenman & Guan Jun Wang, 2012. "New Insights on the Implied and Realized Volatility Relation," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 15(01), pages 1-22.
    • Handle: RePEc:wsi:rpbfmp:v:15:y:2012:i:01:n:s0219091511500032
    DOI: 10.1142/S0219091511500032
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    References listed on IDEAS

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    1. Ederington, Louis H. & Guan, Wei, 2010. "Longer-Term Time-Series Volatility Forecasts," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 45(4), pages 1055-1076, August.
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    Cited by:

    1. Leonidas S. Rompolis & Elias Tzavalis, 2017. "Retrieving risk neutral moments and expected quadratic variation from option prices," Review of Quantitative Finance and Accounting, Springer, vol. 48(4), pages 955-1002, May.
    2. Yam Wing Siu, 2018. "Volatility Forecast by Volatility Index and Its Use as a Risk Management Tool Under a Value-at-Risk Approach," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 21(02), pages 1-48, June.
    3. Yam Wing Siu, 2020. "Impact of Expected Shortfall Approach on Capital Requirement Under Basel," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 22(04), pages 1-34, January.
    4. Oleg Sokolinskiy, 2020. "Conditional dependence in post-crisis markets: dispersion and correlation skew trades," Review of Quantitative Finance and Accounting, Springer, vol. 55(2), pages 389-426, August.

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    More about this item

    Keywords

    Option; implied volatility; realized volatility; forecasting; informational content; vega;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services
    • G3 - Financial Economics - - Corporate Finance and Governance

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