Mar 5, 2013

Forecast Volatility with Skew

I came across a research paper "Corridor Volatility Risk and Expected Returns" the other day. To summarize in one sentence researchers construct volatility indexes using a subsets of SPX options, e.g. call VIX or put VIX, and find that equity risk premium is correlated to call VIX, not put VIX.

That gave me an idea to check the same on volatility risk premium - or alternatively figure out a better way to forecast future realized volatility using skew information. I regressed VIX on following 22-day realized volatility ( beta ~ 0.75 ) and tried to correlate residuals to CBOE SKEW Index (and couple of different transformations of SKEW Index).

Result: nothing; I did not find any way to improve volatility forecasts using SKEW. I don't know if there is really no relationship - I suspect that there is one, and I just failed to figure it out. If you have more success that me, please send an email.

3 comments:

  1. SKEW is an indicator of steepness on both wings, not call vs put.

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  2. Charlie Lefaux3/05/2013

    The null hypothesis is very important.

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  3. @experquisite : SKEW is constructed from calls and puts and is a measure of asymmetry of implied distribution, not steepness.

    @Charlie Lefaux: explain?

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