Forecasting with Option-Implied Information
Handbook of Economic Forecasting, Volume 2, G. Elliott and A. Timmermann (eds.)
72 Pages Posted: 8 Dec 2011 Last revised: 11 Jul 2012
Date Written: July 10, 2012
This chapter surveys the methods available for extracting information from option prices that can be used in forecasting. We consider option-implied volatilities, skewness, kurtosis, and densities. More generally, we discuss how any forecasting object which is a twice differentiable function of the future realization of the underlying risky asset price can utilize option-implied information in a well-defined manner. Going beyond the univariate option-implied density, we also consider results on option-implied covariance, correlation and beta forecasting, as well as the use of option-implied information in cross-sectional forecasting of equity returns. We discuss how option-implied information can be adjusted for risk premia to remove biases in forecasting regressions.
Keywords: Volatility, skewness, kurtosis, density forecasting, risk-neutral
JEL Classification: G13, G17, C53
Suggested Citation: Suggested Citation