Forecasting Realized Volatility from Option Prices

Abstract

This paper provides a comprehensive evaluation of volatility forecasters, each reflecting a distinct risk preference, for predicting realized volatility of the S&P 500 index from option prices. These forecasters are benchmarked against a risk-neutral counterpart, corresponding to the VIX index. Our empirical analysis shows that the forecaster drawn from Chabi-Yo and Loudis (2020) consistently delivers the strongest performance: it forms rational expectations for realized volatility, achieves superior out-of-sample predictive accuracy, and substantially improves trading outcomes in variance swap strategies. The remaining forecasters also provide effective predictors, whereas the risk-neutral benchmark exhibits relatively weak predictive performance. Incorporating skewness and kurtosis fails to enhance out-of-sample performance, suggesting that the original predictors are sufficient.

This paper is available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5371578