The Implied-Realized Volatility Relation with Jumps in Underlying Asset Prices

50 Pages Posted: 23 Mar 2005  

Bent Jesper Christensen

Aarhus University; Aarhus University; Aarhus University

Morten Ørregaard Nielsen

Queen's University - Department of Economics

Date Written: 2 February 2005

Abstract

Recent developments allow a nonparametric separation of the continuous sample path component and the jump component of realized volatility. We add implied volatility from option prices to this analysis. We show that implied volatility has incremental information relative to both the continuous and jump components of realized volatility, subsuming the information content of both in most of our specifications, when forecasting subsequently realized return volatility. Furthermore, implied volatility has predictive power for future values of both components of realized volatility, consistent with the notions that option markets aggregate information efficiently, and that even the jump component of realized volatility is, to some extent, predictable.

Keywords: Bipower variation, implied volatility, instrumental variables, jumps, options, realized volatility, stock prices, vector autoregressive model, volatility forecasting

JEL Classification: C1, C32, G1

Suggested Citation

Christensen, Bent Jesper and Nielsen, Morten Ørregaard, The Implied-Realized Volatility Relation with Jumps in Underlying Asset Prices (2 February 2005). AFA 2006 Boston Meetings Paper. Available at SSRN: https://ssrn.com/abstract=686021 or http://dx.doi.org/10.2139/ssrn.686021

Bent Jesper Christensen

Aarhus University ( email )

Fuglesangs Alle 4
DK-8210 Aarhus V, 8210
Denmark

Aarhus University ( email )

Fuglesangs Alle 4
DK-8210 Aarhus V, 8210
Denmark

Aarhus University ( email )

Fuglesangs Alle 4
DK-8210 Aarhus V, 8210
Denmark

Morten Orregaard Nielsen (Contact Author)

Queen's University - Department of Economics ( email )

94 University Avenue
Kingston K7L 3N6, Ontario
Canada

HOME PAGE: http://www.econ.queensu.ca/faculty/nielsen/

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