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Volatility Risk Premium in Indian Options Prices
Author(s) -
Garg Sonia
Publication year - 2015
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.21680
Subject(s) - volatility (finance) , economics , implied volatility , volatility risk premium , volatility smile , transaction cost , autoregressive model , econometrics , forward volatility , volatility swap , valuation of options , financial economics , realized variance , risk premium , microeconomics
The article examines the volatility forecasting and option pricing performance of model‐free implied volatility (MFIV) in comparison to that of the forecasts based on model‐free realized volatility (RV). There is evidence that the forecasts based on RV are significantly more efficient and less biased than those based on MFIV, whereas the option prices based on MFIV are significantly more efficient and less biased than those based on RV. These contrasting results can be reconciled by accounting for the volatility risk premium (VRP), which is found to follow an autoregressive process in this study. The significant daily returns, observed for various option strategies used to exploit the VRP, are substantially reduced, when the normal transaction costs are accounted for. Although the VRP is priced in the Indian options market, it can provide economic benefits only to those option writers, who have sufficiently low transaction costs. © 2014 Wiley Periodicals, Inc. Jrl Fut Mark 35:795–812, 2015