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The Importance of the Volatility Risk Premium for Volatility Forecasting

50 Pages Posted: 21 Mar 2013 Last revised: 15 Jun 2014

Marcel Prokopczuk

Leibniz Universit├Ąt Hannover - Faculty of Economics and Management; University of Reading - ICMA Centre

Chardin Wese Simen

University of Reading - ICMA Centre

Date Written: December 29, 2013

Abstract

In this paper, we study the role of the volatility risk premium for the forecasting performance of implied volatility. We introduce a non-parametric and parsimonious approach to adjust the model-free implied volatility for the volatility risk premium and implement this methodology using more than 20 years of options and futures data on three major energy markets. Using regression models and statistical loss functions, we find compelling evidence to suggest that the risk premium adjusted implied volatility significantly outperforms other models, including its unadjusted counterpart. Our main finding holds for different choices of volatility estimators and competing time-series models, underlying the robustness of our results.

Keywords: volatility forecasting, volatility risk premium, implied volatility

JEL Classification: G13, G17

Suggested Citation

Prokopczuk, Marcel and Wese Simen, Chardin, The Importance of the Volatility Risk Premium for Volatility Forecasting (December 29, 2013). Journal of Banking and Finance, Vol. 40, 2014. Available at SSRN: https://ssrn.com/abstract=2236370 or http://dx.doi.org/10.2139/ssrn.2236370

Marcel Prokopczuk (Contact Author)

Leibniz Universit├Ąt Hannover - Faculty of Economics and Management ( email )

Koenigsworther Platz 1
Hannover, 30167
Germany

University of Reading - ICMA Centre ( email )

Whiteknights Park
P.O. Box 242
Reading RG6 6BA
United Kingdom

Chardin Wese Simen

University of Reading - ICMA Centre ( email )

Henley Business School
University of Reading
Reading, RG6 6BA
United Kingdom

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