Journal article

Forecasting the volatility of asset returns: The informational gains from option prices

Vance L Martin, Chrismin Tang, Wenying Yao

INTERNATIONAL JOURNAL OF FORECASTING | ELSEVIER | Published : 2021

Abstract

A new class of forecasting models is proposed that extends the realized GARCH class of models through the inclusion of option prices to forecast the variance of asset returns. The VIX is used to approximate option prices, resulting in a set of cross-equation restrictions on the model's parameters. The full model is characterized by a nonlinear system of three equations containing asset returns, the realized variance, and the VIX, with estimation of the parameters based on maximum likelihood methods. The forecasting properties of the new class of forecasting models, as well as a number of special cases, are investigated and applied to forecasting the daily S&P500 index realized variance using..

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University of Melbourne Researchers

Grants

Awarded by Australian Research Council


Funding Acknowledgements

We are grateful to participants at the International Symposium on Forecasting, the Time Series and Forecasting Symposium, and the Australian New Zealand Econometrics Study Group Conference for helpful comments. We would also like to thank the Associate Editor and two anonymous referees for their constructive suggestions on improving previous versions of the paper. This work is supported by the Australian Research Council (Grant no.: DP160102350).