The Information Content of Implied Volatility Indexes for Forecasting Volatility and Market Risk

Abstract

In this paper, we assess the efficiency, information content and unbiasedness of volatility forecasts based on the VIX/VXN implied volatility indexes, RiskMetrics and GARCH-type models at the 5-, 10- and 22-day time horizon. Our empirical application focuses on the S&P100 and NASDAQ100 indexes. We also deal with the information content of the competing volatility forecasts in a market risk (VaR type) evaluation framework. The performance of the models is evaluated using LR, independence, conditional coverage and density forecast tests. Our results show that volatility forecasts based on the VIX/VXN indexes have the highest information content, both in the volatility forecasting and market risk assessment frameworks. Because they are easy-to-use and compare very favorably with much more complex econometric models that use historical returns, we argue that options and futures exchanges should compute implied volatility indexes and make these available to investors.

Keywords: VIX, Implied volatility, Volatility forecast, VaR, Density forecasts