publication . Preprint . Other literature type . Article . 2006

Long Memory and the Relation between Implied and Realized Volatility

Benoit Perron; Federico M. Bandi;
Open Access
  • Published: 09 Aug 2006
Abstract
We argue that the conventional predictive regression between implied volatility (regressor) and realized volatility over the remaining life of the option (regressand) is likely to be a fractional cointegrating relation. Since cointegration is associated with long-run comovements, this finding modifies the usual interpretation of such regression as a study towards assessing option market efficiency (given a certain option pricing model) and/or short-term unbiasedness of implied volatility as a predictor for realized volatility, thereby rendering the conventional tests invalid. We use spectral methods and exploit the long memory in the data to design an econometri...
Subjects
free text keywords: Economics and Econometrics, Finance, jel:G10, Volatility smile, Implied volatility, Econometrics, Financial economics, Forward volatility, Variance swap, Stochastic volatility, Economics, Volatility swap, Volatility (finance), Volatility risk premium
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