Title: A model-free option-implied volatility for forecasting returns and realized volatility
Authors: Xingzhi Yao - Lancaster University (United Kingdom) [presenting]
Marwan Izzeldin - Lancaster University Management School (United Kingdom)
Abstract: The VIX has long been identified to suffer from non-trivial measurement errors due to flaws in implementation of the index by the Chicago Board Options Exchange (CBOE). This has stimulated the development of alternative measures such as the model-free implied volatility (MFIV) and corridor implied volatility (CX). The aforementioned estimators (MFIV and CX) are enhanced by using different interpolation-extrapolation techniques and highlight the importance of the risk-neutral measure in recovering extreme option prices. The refined measures are found superior in terms of forecasting realised volatility and predicting future returns as evident in both the Monte Carlo simulations and an empirical application. Our findings indicate that the tail risk captured by the measures of implied volatility is critical in predicting returns but hampers the forecasting power for future volatility. Our conclusions are robust across different forecasting models, market conditions, and the various procedures of extrapolating option prices.