Which implied volatility provides the best measure of future volatility?

Guan Jun Wang, Pierre Yourougou, Yue Dong Wang

Research output: Contribution to journalArticle

2 Scopus citations

Abstract

The volatility smile/skew phenomenon makes it unclear which implied volatility provides the best measure of the market volatility expectation over the remaining life of the option. Due to the high liquidity of at-the-money option and the low sensitivity of its implied volatility to the price error, the at-the-money implied volatility is often considered a good measure of future volatility. In this paper, we raise the question: is at-the-money implied volatility the best we can do? We provide in this paper an analytical rationale that the implied volatility from option with highest vega outperforms the at-the-money implied volatility in terms of forecasting ability, especially for long forecasting horizons. Our empirical findings are consistent with our theoretical argument.

Original languageEnglish (US)
Pages (from-to)93-105
Number of pages13
JournalJournal of Economics and Finance
Volume36
Issue number1
DOIs
StatePublished - Jan 1 2012

Keywords

  • Black-Scholes Model
  • Hypothesis
  • Implied Volatility
  • Informational Content
  • Option
  • Volatility Smile

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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