The Implied-Realized Volatility Relation with Jumps in Underlying Asset Prices
Bent Jesper Christensen
University of Aarhus - Department of Economics; University of Aarhus - CREATES; University of Aarhus - School of Economics and Management
Morten Ørregaard Nielsen
Queen's University - Department of Economics
2 February 2005
AFA 2006 Boston Meetings Paper
Recent developments allow a nonparametric separation of the continuous sample path component and the jump component of realized volatility. We add implied volatility from option prices to this analysis. We show that implied volatility has incremental information relative to both the continuous and jump components of realized volatility, subsuming the information content of both in most of our specifications, when forecasting subsequently realized return volatility. Furthermore, implied volatility has predictive power for future values of both components of realized volatility, consistent with the notions that option markets aggregate information efficiently, and that even the jump component of realized volatility is, to some extent, predictable.
Number of Pages in PDF File: 50
Keywords: Bipower variation, implied volatility, instrumental variables, jumps, options, realized volatility, stock prices, vector autoregressive model, volatility forecasting
JEL Classification: C1, C32, G1
Date posted: March 23, 2005
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