Investigating the information content of the model-free volatility expectation by Monte Carlo methods

Document Type

Journal article

Source Publication

Journal of Futures Markets

Publication Date

11-1-2013

Volume

33

Issue

11

First Page

1071

Last Page

1095

Publisher

John Wiley & Sons, Inc.

Abstract

We explore the impact of both the number of option prices and the measurement errors in option prices upon the information content of the model-free volatility expectation, and compare it with the Black–Scholes at-the-money (ATM) implied volatility. We simulate the realized volatility process and option prices using Heston's price dynamics and option valuation formula. The results show that the model-free volatility expectation always contains important information about future realized volatilities. When the option prices contain random measurement noise, the informational efficiency of the model-free volatility expectation increases monotonically with the number of out-of-the-money options. The model-free volatility expectation outperforms the ATM implied volatility, except when there are only a few option price observations. For the traded strikes for S&P 500 index options, we further show that fitting implied volatility curves before applying the current CBOE procedure for constructing the VIX index can improve the VIX's efficiency when forecasting future realized volatilities.

DOI

10.1002/fut.21570

Print ISSN

02707314

E-ISSN

10969934

Funding Information

Financial support from the Research Committee of LingnanUniversity (grant no. DB09A2).

Publisher Statement

Copyright © 2012 Wiley Periodicals, Inc.

Access to external full text or publisher's version may require subscription.

Full-text Version

Publisher’s Version

Language

English

Recommended Citation

Zhang, Y., Taylor, S. J., & Wang, L. (2013). Investigating the information content of the model-free volatility expectation by Monte Carlo methods. Journal of Futures Markets, 33(11), 1071-1095. doi: 10.1002/fut.21570

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