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Market imperfections and the information content of implied and realized volatility

Wong, Woon K. and Tu, A. H. 2009. Market imperfections and the information content of implied and realized volatility. Pacific-Basin Finance Journal 17 (1) , pp. 58-79. 10.1016/j.pacfin.2007.12.002

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Abstract

The information content of option implied volatility and realized volatility under market imperfections are studied in the context of GARCH modeling and volatility forecasts of Taiwan stock market (TAIEX) returns. Consistent with most studies, we find that the Taiwan implied volatility index (TVIX) calculated from the TAIEX option prices contains most of the information, and that White's [White, H., 2000. A reality check for data snooping. Econometrica 68, 1097–1126] reality check test cannot reject the null hypothesis that the TVIX provides the best forecast. Possibly due to market imperfections, however, the incremental information content of realized volatility as well as daily returns cannot be ruled out. Finally, we also find that the information is found only in the most recent TVIX, indicating information is being efficiently impounded on the TAIEX option prices. This finding suggests that appropriately designed derivative products can alleviate the problems caused by market imperfections.

Item Type: Article
Date Type: Publication
Status: Published
Schools: Business (Including Economics)
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HF Commerce
H Social Sciences > HG Finance
Uncontrolled Keywords: Market imperfections; Implied volatility; Realized volatility; Volatility forecasts; Reality Check test
Publisher: Elsevier
ISSN: 0927-538X
Last Modified: 04 Jun 2017 05:10
URI: http://orca-mwe.cf.ac.uk/id/eprint/49185

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