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http://ssrn.com/abstract=943317
 
 

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The Economic Value of Using Realized Volatility in Forecasting Future Implied Volatility


Wing H. Chan


Wilfrid Laurier University - Department of Economics; City University of Hong Kong (CityUHK) - Department of Economics & Finance

Ranjini Jha


University of Waterloo - School of Accounting and Finance

Madhu Kalimipalli


Wilfrid Laurier University - School of Business & Economics

November 1, 2008


Abstract:     
We examine the economic benefits of using realized volatility to forecast future implied volatility for pricing, trading, and hedging in the S&P 500 index options market. We propose an encompassing regression approach to forecast future implied volatility and hence future option prices by combining historical realized volatility and current implied volatility. An analysis of delta-neutral straddles and naked and delta-hedged option positions shows that the statistical superiority of historical realized volatility demonstrated in the encompassing regressions and option pricing errors does not translate into economic gains, when trading and hedging in the options markets, after considering trading costs.

Number of Pages in PDF File: 42

Keywords: realized volatility, implied volatility, combination forecasts, volatility timing, option strategie

JEL Classification: G10, G14

working papers series


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Date posted: November 19, 2006 ; Last revised: December 26, 2008

Suggested Citation

Chan, Wing H. and Jha, Ranjini and Kalimipalli, Madhu, The Economic Value of Using Realized Volatility in Forecasting Future Implied Volatility (November 1, 2008). Available at SSRN: http://ssrn.com/abstract=943317 or http://dx.doi.org/10.2139/ssrn.943317

Contact Information

Wing H. Chan
Wilfrid Laurier University - Department of Economics ( email )
Waterloo, Ontario N2L 3C5
Canada
519-884-0710, ext. 2773 (Phone)
519-888-1015 (Fax)
City University of Hong Kong (CityUHK) - Department of Economics & Finance ( email )
83 Tat Chee Avenue
Kowloon
Hong Kong
Ranjini Jha
University of Waterloo - School of Accounting and Finance ( email )
Waterloo, Ontario N2L 3G1
Canada
Madhu Kalimipalli (Contact Author)
Wilfrid Laurier University - School of Business & Economics ( email )
Waterloo, Ontario N2L 3C5
CANADA
519-884-0710 (Phone)
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