ARE VOLATILITY EXPECTATIONS CHARACTERIZED BY REGIME SHIFTS? EVIDENCE FROM IMPLIED VOLATILITY INDICES

This paper examines nonlinearities in the dynamics of volatility expectations using benchmarks of implied volatility for the US and Japanese markets. The evidence from Markov regime-switching models suggests that volatility expectations are likely to be governed by regimes featuring a long memory process and significant leverage effects. Market volatility is expected to increase in bear periods and decrease in bull periods. Leverage effects constitute thus an important source of nonlinearities in volatility expectations. There is no evidence of long swings associated with financial crises, which do not have the potential of shifting volatility expectations from one regime to another for long protracted periods.Markov Regime Switching, Implied Volatility Index, Nonlinear Modelling.

STOCK MARKET VOLATILITY AND THE FORECASTING ACCURACY OF IMPLIED VOLATILITY INDICES

This study develops a new model-free benchmark of implied volatility for the Japanese stock market similar in construction to the new VIX based on the S&P 500 index. It also examines the stochastic dynamics of the implied volatility index and its relationship with realized volatility in both markets. There is evidence that implied volatility is governed by a long-memory process. Despite its upward bias, implied volatility is more reflective of changes in realized volatility than alternative GARCH models, which account for volatility persistence and the asymmetric impact of news. The implied volatility index is also found to be inclusive of some but not all information on future volatility contained in historical returns. However, its higher out-of sample performance provides further support to the rationale behind drawing inference about future stock market volatility based on the incremental information contained in options prices.Licensing; Implied volatility index, Out-of-sample forecasting, GARCH modelling