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.
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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