The Economic Value of Realized Volatility: Using High-Frequency Returns for Option Valuation
University of Toronto - Rotman School of Management; Copenhagen Business School; University of Aarhus - CREATES
Bank of Canada
University of Houston - C.T. Bauer College of Business
University of Toulouse 1 - Toulouse School of Economics (TSE)
December 6, 2012
AFA 2013 San Diego Meetings Paper
Many studies have documented that daily realized volatility estimates based on intraday returns provide volatility forecasts that are superior to forecasts constructed from daily returns only. We investigate whether these forecasting improvements translate into economic value added. To do so we develop a new class of affine discrete-time option valuation models that use daily returns as well as realized volatility. We derive convenient closed-form option valuation formulas and we assess the option valuation properties using S&P500 return and option data. We find that realized volatility reduces the pricing errors of the benchmark model significantly across moneyness, maturity and volatility levels.
Number of Pages in PDF File: 51
Keywords: Realized volatility, index options, risk premium, heteroskedasticity
JEL Classification: G12, G13working papers series
Date posted: March 18, 2010 ; Last revised: December 8, 2012
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