Why does Option Implied Volatility Forecast Realized Volatility? Evidence from News Events

Abstract

We examine the information content of stock option implied volatility. We measure arrival intensities and magnitudes of various types of news, and find that these news measures are all positively associated with contemporaneous stock return volatility and many of them can be predicted by implied volatility. About 28% of the predictive power of implied volatility on future realized volatility is due to its ability to predict these news measures, and most of the predictive power is from predicting arrival intensities of both scheduled and unscheduled news. The predictive power is higher for fundamental news than for non-fundamental news.