Forecast performance of implied volatility and the impact of the volatility risk premium

Ralf Becker (), Adam Clements and Christopher Andrew Coleman-Fenn ()
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Ralf Becker: Manchester

No 45, NCER Working Paper Series from National Centre for Econometric Research

Abstract: Forecasting volatility has received a great deal of research attention, with the relative performance of econometric models based on time-series data and option implied volatility forecasts often being considered. While many studies find that implied volatility is the preferred approach, a number of issues remain unresolved. Implied volatilities are risk-neutral forecasts of spot volatility, whereas time-series models are estimated on risk-adjusted or real world data of the underlying. Recently, an intuitive method has been proposed to adjust these risk-neutral forecasts into their risk-adjusted equivalents, possibly improving on their forecast accuracy. By utilising recent econometric advances, this paper considers whether these risk-adjusted forecasts are statistically superior to the unadjusted forecasts, as well as a wide range of model based forecasts. It is found that an unadjusted risk-neutral implied volatility is an inferior forecast. However, after adjusting for the risk premia it is of equal predictive accuracy relative to a number of model based forecasts.

Keywords: Implied volatility; volatility forecasts; volatility models; volatility risk premium; model confidence sets (search for similar items in EconPapers)
JEL-codes: C12 C22 G00 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ets, nep-for and nep-pke
Date: 2009-07-21
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Persistent link: http://EconPapers.repec.org/RePEc:qut:auncer:2009_58

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