Does the option market produce superior forecasts of noise-corrected volatility measures?
Article first published online: 4 DEC 2008
Copyright © 2008 John Wiley & Sons, Ltd.
Journal of Applied Econometrics
Volume 24, Issue 1, pages 77–104, January/February 2009
How to Cite
M. Martin, G., Reidy, A. and Wright, J. (2009), Does the option market produce superior forecasts of noise-corrected volatility measures?. J. Appl. Econ., 24: 77–104. doi: 10.1002/jae.1033
- Issue published online: 16 DEC 2008
- Article first published online: 4 DEC 2008
- Manuscript Revised: 2 OCT 2007
- Manuscript Received: 25 MAY 2006
- Australian Research Council Discovery. Grant Number: DP0664121
This paper assesses the robustness of the relative performance of spot- and options-based volatility forecasts to the treatment of microstructure noise. Robustness of the results to the method of constructing option-implied forecasts is also investigated. Using a test for superior predictive ability, model-free implied volatility, which exploits information in the volatility ‘smile’, and at-the-money implied volatility, which does not, are both tested as benchmark forecasts of a range of alternative volatility proxies. The results provide compelling evidence against the model-free forecast for three Dow Jones Industrial Average stocks, over a 2001–2006 evaluation period. In contrast, the at-the-money implied volatility forecast is given strong support for the three equities over this period. Neither benchmark is supported for the S&P500 index. Importantly, the main qualitative results are invariant to the method of noise correction used in measuring future volatility. Copyright © 2008 John Wiley & Sons, Ltd.