Measuring Implied Volatility: Is an Average Better?
30 Pages Posted: 31 Oct 2000
Date Written: August 2000
Abstract
Based on the law of large numbers, several options researchers have proposed using (different) weighted averages of the implied standard deviations, ISD, calculated from numerous options with the same expiry to obtain a single best ISD measure. However, most commercial providers use an average (and often an equally weighted average) of just a few at-the-money ISDs. We find that the practitioners' restricted averages forecast slightly better than the broader weighted averages from the academic literature but that neither group forecasts actual volatility very well.
We suggest an adjustment to the extant models which improves their forecasting ability considerably. We also suggest a new weighting scheme which yields better estimates on an out-of-sample basis than any of the existing models (adjusted or unadjusted). However, we also find that because there is little independent noise in individual options ISDs (at least in the S&P 500 options market), there is little gain to averaging. Consequently, individual option ISDs and averages of just a few ISDs forecast almost as well as weighted averages of many ISDs and the weighting scheme choice is relatively unimportant.
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
By Bevan Blair, Ser-huang Poon, ...
-
By Peter Carr and Liuren Wu
-
The Relationship between Implied and Realized Volatility in the Danish Option and Equity Markets