Predicting S&P 500 volatility for intermediate time horizons using implied forward volatility

Abstract

This paper finds that the implied forward volatility of S&P 500 futures options contains significant explanatory power regarding sunsequent realized volatility during intermediate future time intervals. It provides rational, unbiased, and informationally efficient predictions and dominates all alternative volatility forecasts considered.

Notes

¹ Higher order ARCH(q) or GARCH(p,q) models violated the nonnegativity constraints or displayed explosive behaviour. Increasing the sampling frequencies to weekly and daily was not useful, as the forecasts quickly reverted to the unconditional mean.

² Black's (1976) pricing model provides unbiased estimates for both stochastic volatility assumption and American exercise feature when at-the-money options are used (Heston, 1993; Barone-Adesi and Whaley, 1987).