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The Economic Value of Realized Volatility: Using High-Frequency Returns for Option Valuation

Published online by Cambridge University Press:  28 July 2014

Peter Christoffersen
Affiliation:
peter.christoffersen@rotman.utoronto.ca, Rotman School of Management, University of Toronto, 105 St. George Street, Toronto, ON M5S 3E6, Canada, Copenhagen Business School, and Center for Research in Econometric Analysis of Time Series (CREATES)
Bruno Feunou
Affiliation:
bfeuno@bank-banque-canada.ca, Bank of Canada, Financial Markets Department, 234 Wellington St, Ottawa, ON K1A 0G9, Canada
Kris Jacobs
Affiliation:
kjacobs@bauer.uh.edu, Bauer College of Business, University of Houston, 334 Melcher Hall, Houston, TX 77204
Nour Meddahi
Affiliation:
nour.meddahi@tse-fr.eu, Toulouse School of Economics, 21 Allée de Brienne-Manufacture des Tabacs, 31000 Toulouse, France, Groupe de Recherche en Économie Mathématique et Quantitative (GREMAQ) and Industrial Economic Institute (IDEI).

Abstract

Many studies have documented that daily realized volatility estimates based on intraday returns provide volatility forecasts that are superior to forecasts constructed from daily returns only. We investigate whether these forecasting improvements translate into economic value added. To do so, we develop a new class of affine discrete-time option valuation models that use daily returns as well as realized volatility. We derive convenient closed-form option valuation formulas, and we assess the option valuation properties using Standard & Poor’s (S&P) 500 return and option data. We find that realized volatility reduces the pricing errors of the benchmark model significantly across moneyness, maturity, and volatility levels.

Type
Research Articles
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2014 

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