Abstract
This paper examines the relationship between the volatility implied in option prices and the subsequently realized volatility by using the S&P/ASX 200 index options (XJO) traded on the Australian Stock Exchange (ASX) during a period of 5 years. Unlike stock index options such as the S&P 100 index options in the US market, the S&P/ASX 200 index options are traded infrequently and in low volumes, and have a long maturity cycle. Thus an errors-in-variables problem for measurement of implied volatility is more likely to exist. After accounting for this problem by instrumental variable method, it is found that both call and put implied volatilities are superior to historical volatility in forecasting future realized volatility. Moreover, implied call volatility is nearly an unbiased forecast of future volatility.
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Notes
There are other index options traded on ASX, namely: S&P/ASX 200 property trust index options (XPJ) and S&P/ASX 50 index options (XFL) (see www.asx.com.au). The S&P/ASX 200 index options are chosen for this study because they are the most popular and liquid index options on the ASX.
It was the third Friday before September 2004.
On May 26, 1988 and relaunched on December 8, 1993; and on September 29, 1996 and not relaunched until November 8, 1999.
We are grateful to ASX for providing us with the data.
For example, the volatility smile has been well documented in the literature, see e.g., Hull (2003).
We used an iteration procedure to calculate implied volatility. Explicit formulae can also be employed (e.g., Li 2005).
Index levels and futures contracts do not suffer from such illiquidity problems.
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Li, S., Yang, Q. The relationship between implied and realized volatility: evidence from the Australian stock index option market. Rev Quant Finan Acc 32, 405–419 (2009). https://doi.org/10.1007/s11156-008-0099-2
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DOI: https://doi.org/10.1007/s11156-008-0099-2