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Stock return dynamics, option volume, and the information content of implied volatility
Author(s) -
Mayhew Stewart,
Stivers Chris
Publication year - 2003
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.10084
Subject(s) - implied volatility , volatility smile , forward volatility , volatility (finance) , volatility swap , econometrics , economics , variance swap , stochastic volatility , volatility risk premium , equity (law) , realized variance , sabr volatility model , financial economics , political science , law
This article reports new empirical results on the information content of implied volatility, with respect tomodeling and forecasting the volatility of individual firm returns. The 50 firms with the highest option volumeon the Chicago Board Options Exchange between 1988 and 1995 are examined. First, the results indicate that theability of implied volatility to subsume all relevant information about conditional variance depends on optiontrading volume. For the most active options in the sample, implied volatility reliably outperforms GARCH andsubsumes all information in return shocks beyond the first lag. For these active options, implied volatilityperforms substantially better than indicated by the prior results of Lamoureux and Lastrapes (1993), despite significant methodological improvements in the time‐seriesvolatility models in this study including the use of high‐frequency intraday return shocks. For the loweroption‐volume firms in the sample, the performance of implied volatility deteriorates relative totime‐series volatility models. Finally, compared to a time‐series approach, the implied volatilityof equity index options provides reliable incremental information about future firm‐level volatility.© 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:615–646, 2003