Keywords: Leverage asymmetry, volatility feedback, implied volatility forecast, realized volatility, stochastic volatility model, model misspecification, estimation bias.
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.
Full paper (317 KB PDF)
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Last update: August 15, 2003