Download or read book Is Implied Volatility an Informationally Efficient and Effective Predictor of Future Volatility? written by Louis H. Ederington and published by . This book was released on 1998 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper examines (1) whether implied volatility is an unbiased informationally efficient predictor of actual future volatility and (2) its predictive power. If markets are efficient and the option pricing model is correct, then the implied volatility calculated from option prices should be an unbiased and informationally efficient estimator of future volatility, that is, it should correctly impound all available information including the asset's price history. However, numerous studies have found that implied volatility is not informationally efficient and that historical volatilities have incremental predictive power -- often out-predicting implied volatilities. For the Samp;P 500 options on futures we find the following. One, at least part of the apparent inefficiency of implied volatility from past studies stems from measurement error which biases estimates of the importance of implied volatility downward and of the importance of historical volatility upward. Once we correct for this error, there is no significant inefficiency. Two, implied volatility has strong predictive power -- considerably stronger than found by previous equity index studies. Three, stock market volatility prediction results are quite sensitive to (1) the forecasting horizon and (2) whether the data period covers the October 1987 stock market crash.