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Finance and Economics Discussion Series
Finance and Economics Discussion Series logo links to FEDS home page Volatility Puzzles: A Unified Framework for Gauging Return-Volatility Regressions
Tim Bollerslev and Hao Zhou

Abstract: This paper provides a simple unified framework for assessing the empirical linkages between returns and realized and implied volatilities. First, we show that whereas the volatility feedback effect as measured by the sign of the correlation between contemporaneous return and realized volatility depends importantly on the underlying structural model parameters, the correlation between return and implied volatility is unambiguously positive for all reasonable parameter configurations. Second, the lagged return-volatility asymmetry, or the leverage effect, is always stronger for implied than realized volatility. Third, implied volatilities generally provide downward biased forecasts of subsequent realized volatilities. Our results help explain previous findings reported in the extant empirical literature, and is further corroborated by new estimation results for a sample of monthly returns and implied and realized volatilities for the aggregate S&P market index.

Keywords: Leverage asymmetry, volatility feedback, implied volatility forecast, realized volatility, stochastic volatility model, model misspecification, estimation bias.

Full paper (317 KB PDF)

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Last update: August 15, 2003