Skip to main content
Article thumbnail
Location of Repository

On the role of risk premia in volatility forecasting

By Mikhail Chernov

Abstract

I explain why at-the-money implied volatility is a biased and inefficient forecast of future realized volatility using the insights from the empirical option-pricing literature. First, I explain how the risk premia, which manifest themselves through disparity between objective and risk-neutral probability measures, lead to the disparity between realized and implied volatilities. Second, I show that this disparity is a function of the latent spot volatility, which I estimate using the historical volatility and high–low range. An empirical exercise that is based on at-the-money implied volatility series of foreign currencies and stock market indexes, is supportive of my risk premia-based explanation of the bias

Topics: HB Economic Theory, HG Finance
Publisher: American Statistical Association
Year: 2007
DOI identifier: 10.1198/073500106000000350
OAI identifier: oai:eprints.lse.ac.uk:39393
Provided by: LSE Research Online
Download PDF:
Sorry, we are unable to provide the full text but you may find it at the following location(s):
  • http://www.amstat.org/publicat... (external link)
  • http://eprints.lse.ac.uk/39393... (external link)
  • Suggested articles


    To submit an update or takedown request for this paper, please submit an Update/Correction/Removal Request.