Uncertainty and the volatility forecasting power of option-implied volatility |
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Authors: | Byounghyun Jeon Sung Won Seo Jun Sik Kim |
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Affiliation: | 1. College of Business Administration, Marquette University, Milwaukee, Wisconsin;2. Department of Business Administration, Konkuk University, Gwangjin-gu, Seoul, Republic of Korea;3. Division of International Trade, Incheon National University, Yeonsu-gu, Incheon, Republic of Korea |
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Abstract: | This study investigates the impact of uncertainty on the volatility forecasting power of option-implied volatility. Option-implied volatility is a powerful predictor of future volatility, particularly during periods of high uncertainty. This is consistent with option-implied volatility being largely determined by volatility-informed traders (rather than directional traders) when uncertainty is high. New volatility forecasting models that incorporate such interaction outperform benchmark models, both in- and out-of-sample. The new models also better predict future volatility during the 2008 global financial crisis, for which benchmark models perform poorly. The results are robust to alternative choices of benchmark models, loss functions, and estimation windows. |
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Keywords: | implied volatility realized volatility uncertainty volatility forecasting |
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