Revisiting the long memory dynamics of the implied–realized volatility relationship: New evidence from the wavelet regression |
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| Institution: | 1. Institute of Economic Studies, Charles University, Opletalova 26, 110 00 Prague, Czech Republic;2. Institute of Information Theory and Automation, Czech Academy of Sciences, Pod Vodarenskou Vezi 4, 182 00 Prague, Czech Republic;1. LEE & Economics Dept., University Jaume I, 12071 Castellón, Spain;2. School of Agriculture Policy and Development, University of Reading, UK and LEE & Economics Dept., University Jaume I, Castellón, Spain;3. Political Science Dept., University of Crete and Institute of Applied & Computational Mathematics, Foundation for Research and Technology Hellas and Dusseldorf Institute for Competition Economics, University of Dusseldorf, Germany;4. Economics and Finance Subject Group, Portsmouth Business School, University of Portsmouth, Richmond Building, Portland Street, Portsmouth, Hampshire PO1 3DE, UK;5. Economics Dept., University of Crete, Greece;1. Department of Economic and Social Sciences, Catholic University, Piacenza I-29122, Italy;2. Department of Economics, School of Business, College of Staten Island and Graduate Center, City University of New York, United States;1. Faculty of Economics and Management of Nabeul, ENVIE, University of Carthage, Tunisia and Center for Research on the Economics of the Environment, Agri-food, Transports and Energy (CREATE), Canada;2. Laval University, Department of Agricultural Economics and Consumer Science, CREATE and Egg Industry Economic Research Chair, Canada;3. University of Carthage, Department of Industrial Economics, Polytechnic School of Tunisia, LEGI and Faculty of Economics and Management of Nabeul, Tunisia |
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| Abstract: | The literature studying stock index options confirms severe biases and inefficiencies in using implied volatility as a forecast of future volatility. In this paper, we revisit the implied–realized volatility relationship with wavelet band least squares (WBLS) exploring the long memory of volatility, a possible cause of the bias. Using the S&P 500 and DAX monthly and bi-weekly option prices covering the recent financial crisis, we conclude that the implied–realized volatility relation is driven solely by the lower frequencies of the spectra representing long investment horizons. The findings enable improvement of future volatility forecasts as they support unbiasedness of implied volatility as a good proxy for future volatility in the long run. |
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