Market Imperfections and the Information Content of Implied and Realized Volatility

40 Pages Posted: 13 Feb 2008

See all articles by Woon K. Wong

Woon K. Wong

IMRU, Cardiff Business School

Anthony Tu

National Chengchi University


The information content of option implied volatility and realized volatility under market imperfections are studied in the context of GARCH modeling and volatility forecasts of Taiwan stock market (TAIEX) returns. Consistent with most studies, we find that the Taiwan implied volatility index (TVIX) calculated from the TAIEX option prices contains most of the information, and that White's (2000) reality check test cannot reject the null hypothesis that the TVIX provides the best forecast. Possibly due to market imperfections, however, the incremental information content of realized volatility as well as daily return residuals cannot be ruled out. Finally, we also find that the information is found only in the most recent TVIX, indicating information is being efficiently impounded on the TAIEX option prices. This finding suggests that appropriately designed derivative products can alleviate the problems caused by market imperfections.

Keywords: Market imperfections, implied volatility, realized volatility, volatility forecasts, reality check test

JEL Classification: G14, G15

Suggested Citation

Wong, Woon K. and Tu, Anthony, Market Imperfections and the Information Content of Implied and Realized Volatility. Pacific-Basin Finance Journal, Forthcoming. Available at SSRN:

Woon K. Wong (Contact Author)

IMRU, Cardiff Business School ( email )

Cardiff CF10 3EU
United Kingdom

Anthony Tu

National Chengchi University ( email )

No. 64, Chih-Nan Road
Section 2
Wenshan, Taipei 11623

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