The Economic Value of Using Realized Volatility in the Index Options Market

49 Pages Posted: 22 Jun 2006

See all articles by Madhu Kalimipalli

Madhu Kalimipalli

Lazaridis School of Business and Economics, Wilfrid Laurier University

Wing H. Chan

Wilfrid Laurier University - School of Business & Economics; City University of Hong Kong (CityUHK) - Department of Economics & Finance

Ranjini Jha

University of Waterloo - School of Accounting and Finance

Multiple version iconThere are 2 versions of this paper

Date Written: May 31, 2006

Abstract

We examine the economic benefits of using high frequency volatility measures for pricing, trading and hedging in the S&P 500 index options market. Using the encompassing regression framework, we generate volatility forecasts combining information from long memory high-frequency volatility specifications and option-based implied volatilities. We conduct out-of-sample tests of the volatility forecasts by examining option pricing performance, trading performance based on volatility timing strategies, and the performance of covered options positions for index option writers. Our results support combining forecasts of implied volatility and realized volatility and illustrate that the realized volatility approach has economic value in the context of option pricing and risk management.

Keywords: realized volatility, ARFIMA models, implied volatility, encompassing regressions, combination forecasts, volatility timing, option trading strategies

JEL Classification: G10, G14

Suggested Citation

Kalimipalli, Madhu and Chan, Wing H. and Jha, Ranjini, The Economic Value of Using Realized Volatility in the Index Options Market (May 31, 2006). Available at SSRN: https://ssrn.com/abstract=910969 or http://dx.doi.org/10.2139/ssrn.910969

Madhu Kalimipalli (Contact Author)

Lazaridis School of Business and Economics, Wilfrid Laurier University ( email )

Waterloo, Ontario N2L 3C5
Canada
519-884-0710 (Phone)

HOME PAGE: http://www.madhukalimipalli.com/

Wing H. Chan

Wilfrid Laurier University - School of Business & Economics ( email )

Waterloo, Ontario N2L 3C5
Canada
519-884-0710, ext. 2773 (Phone)
519-888-1015 (Fax)

City University of Hong Kong (CityUHK) - Department of Economics & Finance ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong

Ranjini Jha

University of Waterloo - School of Accounting and Finance ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1 N2L 3G1
Canada

Register to save articles to
your library

Register

Paper statistics

Downloads
307
Abstract Views
1,304
rank
43,365
PlumX Metrics