Forecasting Power of Implied Volatility: Evidence from Individual Equities
23 Pages Posted: 1 Aug 2005
Date Written: July 14, 2005
Assuming use of the correct option pricing model and an efficient market, an option's implied volatility is the market's consensus forecast of future realized volatility over the remaining life of that option. We examine 460 of the S&P 500 firms to demonstrate that 1) implied volatility is a better forecaster of realized volatility than historic volatility or GARCH models and 2) the information content of implied volatility significantly decreases with liquidity. Since individual equity options are American style, we obtain implied volatility from calls and puts separately rather than only calls or pooled data.
Keywords: Implied volatilty, realized volatilty, option volume
JEL Classification: C53, G14
Suggested Citation: Suggested Citation