THE ECONOMIC VALUE OF USING REALIZED VOLATILITY IN FORECASTING FUTURE IMPLIED VOLATILITY |
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Authors: | Wing Hong Chan,Ranjini Jha&dagger ,Madhu Kalimipalli&Dagger |
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Affiliation: | Wilfrid Laurier University; University of Waterloo; Wilfrid Laurier University City University of Hong Kong |
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Abstract: | We examine the economic benefits of using realized volatility to forecast future implied volatility for pricing, trading, and hedging in the S&P 500 index options market. We propose an encompassing regression approach to forecast future implied volatility, and hence future option prices, by combining historical realized volatility and current implied volatility. Although the use of realized volatility results in superior performance in the encompassing regressions and out-of-sample option pricing tests, we do not find any significant economic gains in option trading and hedging strategies in the presence of transaction costs. |
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Keywords: | G10 G14 |
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