Long Memory and the Relation Between Implied and Realized Volatility
We argue that the predictive regression between implied volatility (regressor) and realized volatility over the remaining life of a European option (regressand) is likely to be a fractional cointegrating relation. Because cointegration is associated with long-run comovements, this classical regression cannot be used to test for option market efficiency and short-term unbiasedness of implied volatility as a predictor of realized volatility. Using narrow-band spectral methods, we provide consistent estimates of the long-run relation between implied and realized volatility even when implied volatility is measured with error and/or volatility is priced but the volatility risk premium is unobservable. Although little can be said about short-term unbiasedness, our results largely support a notion of long-run unbiasedness of implied volatility as a predictor of realized volatility. Copyright 2006, Oxford University Press.
Year of publication: |
2006
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Authors: | Bandi, Federico M. ; Perron, Benoit |
Published in: |
Journal of Financial Econometrics. - Society for Financial Econometrics - SoFiE, ISSN 1479-8409. - Vol. 4.2006, 4, p. 636-670
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Publisher: |
Society for Financial Econometrics - SoFiE |
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