Efficiency of Indian Option Market: Estimation of Future Market Volatility Using Implied Volatility

Abstract

Forecasting volatility is a key process in pricing stock and index options. Accurate forecasting of future volatility would facilitate the traders and investors to make an informed decision. The study examines the market efficiency of exchange traded index options in India. We investigate the predictive power of implied volatility of Nifty index options in forecasting the future stock market volatility. The efficient market hypothesis believes that the implied contains all past information, thereby making it a superior volatility forecast for the underlying asset. Our study is based on the implied volatility of Nifty index options for the years between 2010 and 2018. In this paper, we compare the accuracy of expected future volatility using implied volatility concerning historical volatility. We study the implied volatility for Nifty 50 index option over the last seven years and compare the results against the ARMA model and historical forecasts to re-establish the superiority of implied volatility and efficiency of the Indian option market.