What Should be Taken into Consideration when Forecasting Oil Implied Volatility Index?

Abstract

This study forecasts the oil volatility index (OVX) incorporating information from other implied volatility (IV) indices. We provide evidence for the existence of long memory in the OVX in order to justify the use of the Heterogeneous AutoRegressive (HAR) model. We extend the HAR model by implementing a dynamic model averaging (DMA) method in order to allow for IV indices from other asset classes to be applicable at different time periods. Apart from the statistical evaluation, a straddle options trading strategy validates our results from an economic point of view. The IV of Dow Jones is highly significant for short- and mid-run forecasting horizons, whereas, at longer horizons, the IV of Energy Sector provides accurate forecasts but only from an economic point of view.