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Uncertainty and the volatility forecasting power of option‐implied volatility
Author(s) -
Jeon Byounghyun,
Seo Sung Won,
Kim Jun Sik
Publication year - 2020
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.22116
Subject(s) - implied volatility , volatility (finance) , forward volatility , volatility smile , volatility swap , econometrics , volatility risk premium , stochastic volatility , economics , benchmark (surveying) , variance swap , sabr volatility model , realized variance , financial economics , geodesy , geography
This study investigates the impact of uncertainty on the volatility forecasting power of option‐implied volatility. Option‐implied volatility is a powerful predictor of future volatility, particularly during periods of high uncertainty. This is consistent with option‐implied volatility being largely determined by volatility‐informed traders (rather than directional traders) when uncertainty is high. New volatility forecasting models that incorporate such interaction outperform benchmark models, both in‐ and out‐of‐sample. The new models also better predict future volatility during the 2008 global financial crisis, for which benchmark models perform poorly. The results are robust to alternative choices of benchmark models, loss functions, and estimation windows.