Implied Volatility Forecasting in the Options Market: A Survey
DOI:
https://doi.org/10.11113/sh.v8n2.721Keywords:
Implied volatility, historical volatility, options, forecasting, literature reviewAbstract
Implied volatility is regarded as one of the most important variables for determining profitability in options trading. Implied volatility gives indication about the future volatility of the underlying asset and can be used to predict the degree to which the asset price might swing and thus whether the options could become profitable before expiration. Volatility forecasting can be grouped into two main categories namely option-implied volatility and historical time-series models. There is an academic debate as to which of the two methods has stronger predictive power. In this paper, we provide a review of options-implied volatility forecasting studies. This survey of the literature suggests there is no consensus to indicate that the implied volatility has stronger predictive power than historical time series in forecasting realized volatility.Â
References
Amin, I. K., & Ng, K.V. (1997). Inferring Future Volatility from the Information in Implied Volatility in Eurodollar Options: A New Approach. The Review of Financial Studies, 10(2), 333-367.
Andersen, T., & Bollerslev, T. (1998). Answering the Skeptics: Yes, Standard Volatility Models Do Provide Accurate Forecast. International Economic Review, 39, 885-905.
Bacha, O.I. (2012). Financial Derivatives : Markets and Applications in Malaysia (3rd ed.), McGraw-Hill (Malaysia) Sdn. Bhd, Shah Alam, Malaysia.
Becker, R., Clements, A.E., & White, S.I. (2006). On the Informational Efficiency of S&P 500 Implied Volatility. North American Journal of Economics and Finance, 17, 139-153.
Beckers, S. (1981). Standard Deviations Implied In Option Prices As Predictors Of Future Stock Price Variability. Journal of Banking & Finance, 5(3), 363-381.
Bentes, S. R. (2015). A Comparative Analysis Of The Predictive Power Of Implied Volatility Indices And GARCH Forecasted Volatility. Physica A: Statistical Mechanics and its Applications, 424, 105-112.
Birkelund, O. H., Haugom, E., Molnár, P., Opdal, M., & Westgaard, S. (2015). A Comparison Of Implied And Realized Volatility In The Nordic Power Forward Market. Energy Economics, 48, 288-294.
Black, F. (1976). The Pricing Of Commodity Contracts. Journal Of Financial Economics, 3(1), 167-179.
Black, F., & Scholes, M. (1973). The Pricing of Option and Corporate Liabilities. The Journal of Political Economy, 81(3), 637-654.
Bluhm, H.H., & Yu, J. (2001). Forecasting Volatility: Evidence from German Stock Market. Working Paper, Economics Department, University of Auckland.
Bollerslev, T. (1986). Generalized Autoregressive Conditional Heterokedasticity. Journal of Economics, 31, 307-327.
Brittenâ€Jones, M., & Neuberger, A. (2000). Option Prices, Implied Price Processes, and Stochastic Volatility. The Journal of Finance, 55(2), 839-866.
Busch, T., Christensen, B. J., & Nielsen, M. Ø. (2011). The Role Of Implied Volatility In Forecasting Future Realized Volatility And Jumps In Foreign Exchange, Stock, And Bond Markets. Journal of Econometrics, 160(1), 48-57.
Canina, L., & Figlewski, S. (1993). The Informational Content of Implied Volatility. Review of Financial Studies, 6(3), 659-681.
Chiras, D. P., & Manaster, S. (1978). The Information Content Of Option Prices And A Test Of Market Efficiency. Journal of Financial Economics, 6(2), 213-234.
Choi, W.C., & Park, S.B. (2014). A Study on the Prediction of Realized Volatility of KOSPI 200 Index Option: Pre & Post the Global Financial Crisis. International Journal of Economics and Finance, 6(12), 15-26.
Christensen, B. J., & Hansen, C. S. (2002). New Evidence On The Implied-Realized Volatility Relation. The European Journal of Finance, 8(2), 187-205.
Christensen, B. J., & Prabhala, N. R. (1998). The Relation Between Implied And Realized Volatility. Journal of Financial Economics, 50(2), 125-150.
Day, T.E., & Lewis, C.M. (1988). The Behaviour of the Volatility Implicit in the Price of Stock Index Option. Journal of Financial Economics, 22(1), 103-122.
Day, T.E., & Lewis, C.M. (1992). Stock Market Volatility and the Information Content of Stock Index Option. Journal of Econometrics, 52(1), 267-287.
Day, T.E., & Lewis, C.M. (1993). Forecasting Future Market Volatility. The Journal of Derivatives, 1(2), 33-50.
Dixit, A., Yadav, S.S., & Jain, P. (2010). Informational Efficiency of Implied Volatilities of S&P CNX Nifty Index Option: A Study in Indian Securities Market. Journal of Advances in Management Research, 7(1), 32-57.
Duan, C.-W., & Lin, J.-C. (2014). The Predictive Power Of Volatility Models: Evidence from the ETF Market. Investment Management and Financial Innovations, 11(2), 100-110.
Ederington, L., & Guan, W. (2002a). Is Implied Volatility an Informationally Efficient and Effective Predictor of Future Volatility? Journal of Risk, 4, 29-46.
Ederington, L., & Guan, W. (2002b). Measuring Implied Volatility: Is an Average Better? Which Average? Journal of Futures Market, 20, 811-837.
Ederington, L., & Guan, W. (2002c). Why are Those Options Smiling? Journal of Derivatives, 10, 9-34.
Ederington, L., & Guan, W. (2005). The Information Frown in Options Prices. Journal of Banking & Finance, 29, 1429-1457.
Engle, R.F. (1982). Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation. Econometrica, 50(4), 987-1008.
Fama, E.F. (1965). The Behaviour of Stock Market Prices. The Journal of Business, 38(1), 34-105.
Filis, G. (2009). An Analysis between Implied Volatility and Realised Volatility in the Greek Derivative Market. Journal of Emerging Market, 8(3), 251-263.
Fleming, J. (1998). The Quality of Market Volatility Forecasts Implied By S&P 100 Index Option Prices. Journal of Empirical Finance. 5(4), 317-345.
Frijns, B., Tallau, C., & Tourani-Rad, A. (2010). The Information Content of Implied Volatility: Evidence from Australia. The Journal of Future Markets, 30(2), 134-155.
Glosten, L., Jagannathan, R., & Runkle, D. (1993). On the Relation Between the Expected Value and the Volatility of the Nominal Excess Return on Stocks. Journal of Finance, 48, 1779-1801.
Guo, D. (1996). The Information Content Of Implied Stochastic Volatility From Currency Options. The Canadian Journal of Economics/Revue Canadienne d'Economique, 29, S559-S561.
Hansen, L. P. (1982). Large Sample Properties of Generalized Method of Moments Estimators. Econometrica: Journal of the Econometric Society, 50(4), 1029-1054
Harvey, C.R., & Whaley, R.E. (1992). Market Volatility Prediction and the Efficiency of the S&P100 Index Option Market. Journal of Financial Economics, 31, 43-73.
Heath, D., Jarrow, R., & Morton, A. (1992). Bond Pricing And The Term Structure Of Interest Rates: A New Methodology For Contingent Claims Valuation. Econometrica: Journal of the Econometric Society, 60(1) (Jan., 1992), 77-105.
Heston, S. L. (1993). A Closed-form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options. Review of Financial Studies, 6(2), 327-343.
Hull, J., & White, A. (1987). The Pricing of Options on Assets with Stochastic Volatilities. The Journal of Finance, 42(2), 281-300.
Jiang, G. G., & Tian, Y. S. (2005). The Model-Free Implied Volatility and Its Information Content. The Review of Financial Studies, 18(4), 1305-1342.
Jing, F. C., & Gui, B. L. (2015). Volatility Forecasting: Model-Free Implied Volatility. International Conference on Education, Management, Commerce and Society (498-501). Atlantis Press.
Joon Byun, S., Woo Rhee, D., & Kim, S. (2011). Intraday Volatility Forecasting From Implied Volatility. International Journal of Managerial Finance, 7(1), 83-100.
Jorion, P. (1995). Predicting Volatility in the Foreign Exchange Market. The Journal of Finance, 50(2), 507-528.
Jorion, P. (1996). Risk and Turnover in the Foreign Exchange Market. in Frankel, J.A., Galli, G., and Giovannini, A. (Eds), The Microstructure of Foreign Exchange Market, University of Chicago Press, 19-40.
Kazantzis, C., & Tessaromatis, N. (2001). Volatility in Currency Market. Managerial Finance, 27(6), 1-22.
Kim, N., & Lee, J. (2013). No-Arbitrage Implied Volatility Functions: Empirical Evidence from KOSPI 200 Index Options. Journal of Empirical Finance, 21, 36-53.
Koopman, S.J., Jungbacker, B., & Hol, E. (2005). Forecasting Daily Variability of the S&P 100 Stock Index using Historical. Realised and Implied Volatility Measurements. Journal of Empirical Finance, 12(3), 445-475.
Kumar, A. V., & Jaiswal, S. (2013). The Information Content Of Alternate Implied Volatility Models: Case of Indian Markets. Journal of Emerging Market Finance, 12(3), 293-321.
Lamoureux, C. G., & Lastrapes, W.D. (1993). Forecasting Stock-Return Variance: Toward and Understanding of Stochastic Implied Volatility. The Review of Financial Studies, 6(2), 293-326.
Latane, H. A., & Rendleman, R. J. (1976). Standard Deviations Of Stock Price Ratios Implied In Option Prices. The Journal of Finance, 31(2), 369-381.
Macbeth, J. D., & Merville, L.J. (1979). An Empirical Examination of the Black-Scholes Call Option Pricing Model. Journal of Finance, 34(5), 1173-1186.
Merton, R. C. (1973). Theory of Rational Option Pricing. The Bell Journal of Economics and Management Science, 4(1), 141-183.
Nelson, D. B. (1991). Conditional Heterocedasticity in Asset Returns: A New Approach. Econometrica, 59, 347-370.
Pilbeam, K., & Langeland, K. N. (2015). Forecasting Exchange Rate Volatility: GARCH Models Versus Implied Volatility Forecasts. International Economics and Economic Policy, 12(1), 127-142.
Poon, S. H., & Granger, C. W. (2003). Forecasting Volatility in Financial Markets: A Review. Journal Of Economic Literature, 41(2), 478-539.
Poon, S. H., & Granger, C. W. (2005). Practical Issues in Forecasting Volatility. Financial Analysts Journal, 61(1), 45-56.
Poon, S. H., Blair, B., & Taylor, S. (2001). Forecasting S&P 100 Volatility: Using High Frequency Data And Implied Volatility. Journal of Econometrics, 105, 5-26.
Powers, E., & Xiao, G. (2014). Mispricing of Chinese Warrants. Pacific-Basin Finance Journal, 30, 62-86.
Prima Sakti, M.R., & Mohamad A. (2015). Implied Volatility in the Options Market: Evidence from Malaysia. Manuscript Submitted for Publication.
Schmalensee, R., & Trippi, R. R. (1978). Common Stock Volatility Expectations Implied By Option Premia. The Journal of Finance, 33(1), 129-147.
Scott, E., & Tucker, A. L. (1989). Predicting Currency Return Volatility. Journal of Banking & Finance, 13(6), 839-851.
Seo, S. W., & Kim, J. S. (2015). The Information Content Of Option-Implied Information For Volatility Forecasting With Investor Sentiment. Journal of Banking & Finance, 50, 106-120.
Shaikh, I., & Padhi, P. (2013). The Information Content Of Implied Volatility Index (India VIX). Global Business Perspectives, 1(4), 359-378.
Shaikh, I., & Padhi, P. (2015). The Implied Volatility Index: Is ‘Investor Fear Gauge’or ‘Forward-Looking’?. Borsa Istanbul Review, 15(1), 44-52.
Shastri, K., & Sirodom, K. (1995). An Empirical Test Of The BS And CSR Valuation Models For Warrants Listed In Thailand. Pacific-Basin Finance Journal, 3(4), 465-483.
Shu, J., & Zhang, J.E. (2003, Jan/Feb). The Relationship Between Implied and Realized Volatility of S&P 500 Index. WILLMOTT Magazine, 83-91.
Singh, V.K. (2013). Effectiveness of Volatility Models in Option Pricing: Evidence from Recent Financial Upheavals. Journal of Advances in Management Research, 10(3), 352-375.
Singh, V.K., & Ahmad, N. (2011). Forecasting Performance of Volatility Models for Pricing S&P CNX Nifty Index Option via Black-Scholes Model. The IUP Journal of Applied Finance, 17(3), 53-67.
Szakmary, A., Ors, E., Kim, J. K., & Davidson, W. N. (2003). The Predictive Power Of Implied Volatility: Evidence From 35 Futures Markets. Journal of Banking & Finance, 27(11), 2151-2175.
Viteva, S., Veld-Merkoulova, Y.V., & Campbell, K. (2014). The Forecasting Accuracy Of Implied Volatility From ECX Carbon Options. Energy Economics, 45, 475-484.
Whaley, R.E. (2000). The Investor Fear Gauge. The Journal of Portfolio Management, 26(3), 12-17.
Wong, W. K., & Tu, A. H. (2009). Market Imperfections And The Information Content Of Implied And Realized Volatility. Pacific-Basin Finance Journal, 17(1), 58-79..
Xu, X., & Taylor, S. J. (1995). Conditional Volatility And The Informational Efficiency Of The PHLX Currency Options Market. Journal of Banking & Finance, 19(5), 803-821.
Zakoian, J. M. (1994). Threshold Heteroskedastic Models. Journal of Economic Dynamics and Control, 18(5), 931-955.
