New Economics Papers
on Market Microstructure
Issue of 2006‒12‒04
one paper chosen by
Thanos Verousis

  1. Implied Volatility using Variance Decomposition Method By Kim, Joocheol; Kim, WooWhan; Kim, KiHyung

  1. By: Kim, Joocheol; Kim, WooWhan; Kim, KiHyung
    Abstract: This paper provides a new method-what is called variance decomposition method- to calculate market volatility index implied in option price and compares the prediction quality of realized volatility with VIX that is well known as volatility index. The volatility using variance decomposition has an advantage, since it reflects market participants’ expectation. Our method is based on the variance calculation decomposed into two components which are conditioned on other variable, strike price in this paper. We use high-frequency data (daily based) to calculate variance decomposition volatility as well as VIX and compare the prediction quality of these indexes for realized volatility. The empirical result shows that variance decomposition volatility index is similar to the dynamics of VIX and shows good prediction power of realized volatility. We also discuss our findings in long range dependence of realized volatility with respect to variance decomposition and VIX.
    Keywords: Realized Volatility; Implied Volatility; Variance decomposition; VIX
    JEL: G13 G12 G32
    Date: 2006–11

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