On the Dynamics and Information Content of Implied Volatility: A Bivariate Time Series Perspective

Abstract

A new research design is introduced for the empirical analysis of the relationship between implied volatility and ex-post realized volatility. The dynamics of volatility are emphasized, and the analysis is cast in terms of non-overlapping data, so that exactly one implied and one realized volatility estimate pertain to each period under consideration. The conclusions from the empirical analysis when using our design are significantly different from those previously reached. Recent literature indicates that implied volatility contains little information about future volatility, beyond that contained in the history of realized volatility. We show that on the contrary, implied volatility efficiently predicts future realized volatility and in particular subsumes the information content of past realized volatility.