Abstract
AbstractThis paper evaluates the ability of alternative option‐implied volatility measures to forecast crude‐oil return volatility. We find that a corridor implied volatility measure that aggregates information from a narrow range of option contracts consistently outperforms forecasts obtained by the popular Black–Scholes and model‐free volatility expectations, as well as those generated by a realized volatility model. This measure ranks favorably in regression‐based tests, delivers the lowest forecast errors under different loss functions, and generates economically significant gains in volatility timing exercises. Our results also show that the Chicago Board Options Exchange's “oil‐VIX” index performs poorly, as it routinely produces the least accurate forecasts.
Highlights
In economic terms, crude‐oil is the most important traded commodity
Using the mean squared error (MSE), QLIKE, and realized utilities as measures of forecast accuracy, we find that the pattern observed over the full out‐of‐sample period is retained in each of the subsamples; the BC‐CIV1 provides the most accurate forecasts according to the MSE while the heterogeneous autoregressive (HAR)‐CIV1 forecasts are the most accurate according to the QLIKE and have the highest realized utility
We examine an alternative technique inspired by Prokopczuk and Simen (2014), who show that the forecasting performance of the model‐free implied volatility (MFIV) can be improved significantly by making a nonparametric adjustment for the variance risk premium
Summary
Crude‐oil is the most important traded commodity. Unsurprisingly, a wide range of economic agents, from individual investors to policy makers, closely monitor its price and routinely attempt to make predictions about the future. In their study of three energy markets, Prokopczuk and Simen (2014) find that MFIV is more informative than ATMIV in predicting either crude‐oil, heating oil, or natural gas volatility They find that a simple adjustment for volatility risk‐premia enhances the forecast performance of all option‐implied measures. The OVX, which is produced and disseminated by the CBOE, intends to measure the market's (risk‐neutral) expectation of crude‐oil price volatility over the month It is defined as the square root of MFIV, given in Equation (4). Moving from high (low) strike, out‐of‐the‐money, put (call) options toward those with lower (higher) strikes, once two contracts with consecutive strike prices have zero bid prices a cut‐off point is applied and no further contracts are considered Both the VIX and the OVX are, in reality, CIV measures, with a corridor width determined by market liquidity. M and Δ are chosen such that M/Δ is an integer
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