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http://hdl.handle.net/2451/26976
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| Title: | Testing the Volatility Term Structure Using Option Hedging Criteria |
| Authors: | Engle, Robert F.
Rosenberg, Joshua V. |
| Issue Date: | Jan-1997 |
| Series/Report no.: | FIN-96-024 |
| Abstract: | The volatility term structure (VTS) reflects market expectations of
average asset volatility over different time horizons. Various
stochastic volatility models provide forecasts of the VTS and how it
shifts in response to changes in market conditions. This paper develops
a methodology for testing VTS forecasts using option hedging
performance. An innovative feature of the hedging approach is its
increased sensitivity to several important forms of model
misspecification relative to previous testing methods. Hedging tests
using S&P 500 index options indicate that the GARCH components with
leverage VTS estimate is most accurate. The poorer hedging performance
of the alternative models suggests that volatility term structure shifts
are related to the magnitude and level of recent returns. Strong
evidence is obtained for mean-reversion in volatility. |
| URI: | http://hdl.handle.net/2451/26976 |
| Appears in Collections: | Finance Working Papers
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