Shaikh Padhi 2014 The Forecasting Performance of Implied Volatility Index Evidence From India VIX

Econ Change Restruct (2014) 47:251–274
DOI 10.1007/s10644-014-9149-z
The forecasting performance of implied volatility index:

evidence from India VIX
Imlak Shaikh • Puja Padhi
Received: 9 October 2013 / Accepted: 7 May 2014 / Published online: 20 May 2014
Ó Springer Science+Business Media New York 2014
Abstract In this paper, we investigate the forecasting performance of ex-post an

ex-ante volatility forecasts against realized return volatility of various time horizon.
The competing volatility forecasts are implied volatility, RiskMetrics and GJR-
GARCH; the empirical results uncover that implied volatility dominates the other
volatility forecast in the prediction of future realized return volatility. The in-sample
forecast suggests that ex-ante volatility best explains the future market volatility.
The non-overlapping sampling procedure gives the more robust estimate of vola-
tility forecasts, the results reveals that implied volatility forecasts of all horizon
appears positive unbiased forecaster of realized volatility. Moreover, the instru-
mental variable estimation in the presence of error-in-variable clears that implied
volatility is free from measurement error; OLS estimates remains more consistent
than the 2SLS estimates. The information content of implied volatility encourages
the exchanges to construct the implied volatility indices and volatility products on
underlying volatility index.
Keywords Information content Ex-ante and ex-post volatility IVIX

India VIX RiskMetrics Measurement error 2SLS
JEL Classification C53 G14
I. Shaikh (&) P. Padhi

Department of Humanities and Social Sciences, Indian Institute of Technology Bombay,
Mumbai 400 076, India
e-mail: imlak786@gmail.com; imlak_n786@iitb.ac.in
P. Padhi
e-mail: pujapadhi@iitb.ac.in
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252 Econ Change Restruct (2014) 47:251–274
1 Introduction
The importance of implied volatility index increases day-by-day among the market
participants and analysts, the rational is that agents can predict the trend of market
with short horizon. For predicting the stock market volatility there are various
volatility models such as ARCH/GARCH-models, stochastic volatility, implied
volatility, realized volatility etc. It has been proved that implied volatility is the best
estimate (at-the-money average implied volatility) among all other estimates of
future realized return volatility (e.g. Christensen and Prabhala 1998; Christensen
and Hansen 2002). The stock market returns and forecasting of future volatility
based on implied volatility index is the recent topics of discussion among the
analysts and academics. The National Stock Exchange of India limited regularly
quotes the price of implied volatility index for the underlying CNX Nifty Equity
index options and this is regularly published by the financial press.
The present study has been motivated by two important issues: First, there is a
lack of studies of this kind in the emerging markets like India. Second, unlike the
previous studies (e.g. Christensen and Prabhala 1998; Christensen and Hansen 2002;
Muzzioli and Baets 2013; Muzzioli 2013a, b) this study deals with the forward-
looking expectation of stock market volatility (i.e. implied volatility index, India
VIX), and other competing volatility forecasts (i.e. implied volatility, RiskMetrics
and GJR-GARCH) based on t ? h forward-looking horizon.
The contribution of the study: (1) to the best of our knowledge no study has been
found in the Indian context that deals with the forecasting performance of implied
volatility, and the work based on the forward-looking forecasts; (2) another most
important contribution of the study is this deals with the non-overlapping samples
(e.g. Christensen et al. 2001) and estimation that takes into account the
measurement issue; (3) the novel aspect of the work is that it provides the stock
market volatility assessment in in-sample and out-of-sample estimation framework;
(4) in addition, the literature contributions is of two folds: First, the study explains
the empirical relationship between ex-post and ex-ante volatility in the emerging
stock market volatility, Second, it extends the literature on the market efficiency of
options market (i.e. implied volatility).
The ex-ante measures of volatility gained more popularity in recent days among
the practitioners, financial institutions and policy makers, and the forecasting of
future market volatility based on historical data now became a less preferred tools.
The researchers and analysts are keenly interested in the stock market volatility
forecast. The traditional ex-post measure of volatility was introduced by J.
P. Morgan in 1992 known as RiskMetrics, and the conditional volatility models
(ARCH/GARCH) based on historical stock returns was put forwarded by Robert
Engle in 1982. Stock market volatility studies based on ARCH/GARCH type
framework gives one period ahead forecasts, while studying the market volatility
through implied volatility index is quite different that having 1 month prediction
horizon. Hence, the motivation of the study is to assess the predictive ability of
implied volatility as the forward-looking forecasts of future realized volatility.
Some of the important studies (e.g. Fleming et al. 1995; Whaley 2000; Blair et al.
2001; Simon 2003; Giot 2002, 2005; Frijns et al. 2008, 2010a) have shown that
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Econ Change Restruct (2014) 47:251–274 253
implied volatility impound significant information to explain future volatility as the

forward-looking tools of future market volatility, hence implied volatility as the
expectation of future stock market volatility contains all relevant information to
explain the realized volatility.
Moraux et al. (1999) examine the predictive ability of French market volatility
index (VX1) based on the multi-horizon, they find a strong relation between future
realized volatility and VX1 volatility index. In particular, they show that CAC 40
options based VX1 index can be applied for calculating volatility forecasts of
various horizon and the forecasts can be used to predict the future stock market
volatility. Claessen and Mittnik (2002) investigate the informational efficiency of
German DAX-index options market and forecast the stock market volatility. The
stock market volatility has been estimated using ARCH\GARCH type framework
and they conclude that historical returns do not contain information beyond the
market’s volatility expectation that is reflected in DAX-options prices. Poon and
Granger (2003) explore the importance of volatility forecasting in the financial
market, and it has been observed that implied volatility outperform the other
competing volatility forecasts (such as historical returns volatility, lagged realized
volatility and ARCH\GARCH conditional volatility).
Dowling and Muthuswamy (2005) examine the properties of Australian implied
volatility index (AVIX) in the form of seasonality and the information content of
AVIX as the predictor of future volatility. They find strong seasonality and
contemporaneous asymmetric relation between AVIX and stock returns. Similarly,
Frijns et al. (2010a, b) revisits the study of Dowling and Muthuswamy (2005) and
supports the previous work for the more recent period from 2002 to 2006.
Yang and Liu (2012) recently analyze the forecasting power of TVIX as the
predictor of future volatility for Taiwan stock market. The empirical evidences
show that the volatility index is a strong indicator of future stock market volatility
and TVIX outperforms the stock index returns volatility (i.e. historical and
GARCH) forecasts. Kanas (2012) examine the risk-return relation between S&P
100 index and implied volatility index (VIX) using variant of GARCH-M model, he
believes that by allowing VIX as an exogenous factor improves the precision of the
conditional variance measurement, and find positive risk-return relation. Similarly,
Kozyra and Lento (2011) analyze the trading signal based on implied volatility
levels and suggests that VIX level provides large amount of profits, and reveals that
a relationship holds among the level of expected volatility and profitability.
Siriopoulos and Fassas (2012) investigate the Greek implied volatility index (GRIV)
based on the FTSE\ATHEX-20 index options, they find GRIV index best explains
the future realized volatility beyond that impound in the historical volatility.
Some of the earlier studies (e.g. Chiras and Manaster 1978; Christensen and
Prabhala 1998; Christensen and Hansen 2002; Corrado and Miller 2005; Muzzioli
2007, 2010a, b, 2012; Li and Yang 2009; Shaikh and Padhi 2013a, b) they conclude
that implied volatility subsume all the information that contained in the historical
volatility. The studies (see e.g. Daigler and Rossi 2006; Konstantinidia et al. 2008;
Szado 2009; Chung et al. 2011; Konstantinidi and Skiadopoulos 2011; Shu and
Zhang 2012) they demonstrates the informational efficiency of implied volatility
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index and show that volatility products (VIX F&Os) are helpful in the price
discovery and portfolio risk management.
The aim of this paper is to analyze the information content of various volatility
forecasts as the forecaster of future realized return volatility. We calculate various
competing volatility forecasts of h-day horizon such as: implied volatility,
RiskMetrics and GJR-GARCH. The study employs in-sample and out-of-sample
forecasting framework in order to assess the performance of implied volatility and
other historical return volatility. The in-sample ARCH/GARCH estimation shows
that implied volatility out-performs the historical return volatility in explaining the
stock market volatility. The out-of-sample volatility forecasts (horserace regression)
reveal that implied volatility dominates the other ex-post volatility forecasts. The
second best candidate for the volatility prediction is RiskMetrics. In addition, the
2SLS regression have been performed to resolve the EIV problem, and it is found
that implied volatility is free from measurement error and OLS estimates are more
consistent that 2SLS.
The work has been organized as: Sect. 1 provides introduction and related
literature. Section 2 explains data sources and calculation of volatility forecasts.
Section 3 discusses the empirical model. Section 4 presents the empirical result and
Sect. 5 ends with the conclusions and practical implication.
2 Data sources and volatility forecast
This section describes the information content of implied volatility as the forecast of
the future realized return volatility. In addition, ex-post and ex-ante volatility
forecasts have been calculated and compared.
2.1 Data sources
This study investigates the forecasting ability of implied volatility and the
information content of various volatility forecasts of different forecast horizon. The
daily closing prices of India VIX and the underlying S&P CNX Nifty equity1 index
has been collected from the National Stock Exchange of India (NSE). The sample
period consist of 11/01/2007 to 04/30/2013. Stock price indices are calculated using
the prices of their component stocks, while VIX is a volatility index comprised of
the options rather than stock prices.
The study takes into account two indices namely implied volatility index (India
VIX) and S&P Nifty equity index about span of 6 years daily data. The India VIX
constructed as the methodology suggested by CBOE for VIX with the required
changes. The implied volatility is approximated for the observed European option
price written on S&P Nifty equity index. The Nifty index is the benchmark stock
index for the Indian economy for the 50 stocks and adjusted for the ex-dividend
1
The options written on Nifty index are based on the daily closing of the CNX Nifty 50 stocks index,
options are not written on total returns index, hence there is no issue of dividend yield consideration in
implied volatility calculation.
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dates. The implied volatility might be subject to measurement error; hence we

employ instrumental variable-2SLS procedure. The 2SLS method explains that
implied volatility is free from measurement error; hence the data on implied
volatility index is clean and less prone to measurement errors.
2.2 Forecasting ability of implied volatility
This section presents the forecasting ability of implied volatility index as the
forecasts of future stock market return volatility. The in-sample and out-of-sample
forecasting framework has been reported in order to check the predicative ability of
implied volatility index. The assessment of the stock market volatility could have
been presented in two ways: (1) in-sample framework that provides only the
estimation of the volatility within the sample period, but the parsimony of the model
cannot be judged (2) out-of-sample framework provides an insight about the
competing nature of volatility forecasts, that one can use to forecast the future stock
market volatility.
The option’s implied volatility is the forward-looking expectation of the future
stock market volatility; hence implied volatility subsumes important information to
explain the future volatility. Some of the studies (e.g. Day and Lewis 1992; Xu and
Taylor 1995; Blair et al. 2001; Giot 2002, 2005) have been assessed the
informational efficiency of implied volatility in conditional variance framework.
More recently, the empirical work of Fleming et al. (1995), Simon (2003), Giot
(2002, 2003, 2005) and Frijns et al. (2010a, b) on the forecasting ability of implied
volatility index for in-sample and out-of-sample framework prove that implied
volatility outperforms the conditional volatility as the best forecasts of future
realized volatility.
2.2.1 Implied volatility in ARCH/GARCH-type models
The empirical studies on implied volatility index in ARCH/GARCH type

framework also have been suggested to take lagged implied volatility as an
additional regressor in the variance equation. To analyze the effectiveness of
implied volatility, the variance equation is estimated by inclusion and exclusion of
lagged volatility. The present study is motivated by empirical work of Blair et al.
(2001) and Giot (2002, 2005) expressed in terms of GARCH(1,1) specification.2
Let; Rt ¼ l þ ut ð1Þ
ut N(0, ht Þ
ht ¼ x þ a1 u2t1 þ b1 ht1 þ b2 It1 u2t1 þ cIVIXt1
2
ð2Þ
where Rt = ln(Niftyt/Niftyt-1) is the log return of S&P CNX Nifty equity index of
daily closing, l = is the mean of daily return, ut = is the shock/innovation in the
daily log return, further this innovation is assumed to be zero and conditional
2
For example, Brissimis et al. (2012) and Papapetrou (2013) demonstrate the practical implication of
using GARCH-model in European markets.
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variance as ht, It-1 = is the indicator variable that captures the asymmetric impact
of shocks on volatility, which assumes one for the ut \ 1 and otherwise zero.
A variant of GARCH is estimated by taking: First, when we set b2 = c = 0 then
the Eq. (2) become standard GARCH(1,1), Second, when we take c = 0, it collapse
to GJR-GARCH(1,1) model of Glosten et al. (1993). Third, by taking b1 = b2 = 0
it result into basic ARCH-IVIX model in which the conditional variance is
explained by implied volatility. In particular, the restriction b1 = 0, the market
innovation, asymmetry and implied volatility, explains the market volatility.
Finally, without putting any constraints on the parameter of variance equation, we
can have GJR-GARCH(1,1) model with and exogenous variable IVIX. The rational
of taking lagged squared values of implied volatility in the variance equation is to
analyze the information content of implied volatility to explain the stock market
volatility. This enables to determine the market volatility from the behavior of
options market (i.e. implied volatility), and also explain the non-linear impact of
implied volatility on the stock market volatility.
2.2.2 The measures of volatility forecast
In the previous section we have been evaluated the volatility forecasts in in-sample
framework. In this section we demonstrate the forecasting performance of implied
volatility and volatility forecasts based on historical returns using out-of-sample
framework. We present the forecasting ability of implied volatility, RiskMetrics and
GJR-GARCH at various time horizon of h-day (i.e. 1-, 5-, 10-, 22-, and 66-day).
2.2.2.1 Implied volatility index The National Stock Exchange of India (NSE) has
introduced India VIX form November, 2007, using the methodology as developed
by CBOE, 2003. India VIX is the forward-looking expectation of future market
volatility of 30 days horizon (20–22 trading days) and it is expressed in annualized
terms. Therefore, Giot (2005) suggest ‘square root of time rule’ to move from a time
horizon of 22 days to the required h-day interval, i.e. the h-day forward-looking
forecast on day t for S&P CNX Nifty index is equal to
rffiffiffiffiffiffiffiffi
h
rIVIX h;t ¼ IVIXt ð3Þ
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Hence, rIVIX h,t is the expected volatility over the period [t ? 1, t ? h]
2.2.2.2 RiskMetrics forecasts The RiskMetrics model for volatility on date t is

given by
rRMt ¼ ð1 kÞR2t1 þ krRMt1 ð4Þ
where Rt = ln(Niftyt/Niftyt-1), k = 0.94 for daily return
The volatility forecast for h-day forward-looking horizon based on RiskMetrics
volatility forecasts is given over the [t ? 1, t ? h] time period by
pffiffiffiffiffiffiffiffiffiffiffiffi
rRM h;t ¼ hrRMt ð5Þ
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2.2.2.3 Standard ARCH/GARCH forecasts The literature has well documented the
success story of ARCH/GARCH (see e.g. Engle 1982; Bollerslev 1986; Bollerslev et al.
1992) model in describing the behavior of stock market return data. Here, we estimate
GJR-GARCH(1,1) model to forecasts the stock return volatility, the specification is
ht ¼ x þ a1 u2t1 þ b1 ht1 þ b2 It1 u2t1 ð6Þ
The k-steps ahead forecast can be easily obtained as

x þ a1 u2t1 þ b1 ht1 þ b2 It1 u2t1 ; for k ¼ 1
htþk ¼
x þ ðb1 þ a1 þ 0:5b2 Þhtþk1 ; for k [ 1
The total volatility for h-day ahead can be obtained as
vffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
u h
uX
rGJR h;t ¼ t htþk ð7Þ
j¼1
Hence, rGJR h,t is the expected volatility forecasts over the period [t ? 1,
t ? h] based on GJR-GARCH(1,1) model.
2.2.2.4 Realized volatility Giot (2005) suggest the following specification to

obtain the forward-looking realized volatility over a time horizon of h-days, and it is
calculated as taking the square root of the sum of the (future) squared returns over
the h-day period. At time t, the realized volatility rRV h,t is
vffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
u h
uX
rRV h;t ¼ t R2tþj ð8Þ
j¼1
where Rt = ln(Niftyt/Niftyt-1), rRV h,t is the ex-post return volatility calculated at

time [t ? h].
All the volatility forecasts estimated using the above equation reports overlap-
ping samples; hence we also calculate the volatility forecasts for non-overlapping
samples. The overlapping sample results into extreme problem of autocorrelation
and affects on the properties of estimated slopes (see e.g. Christensen and Prabhala
1998; Christensen et al. 2001). Hence, the non-overlapping samples for t ? h for-
ward-looking forecast are respectively 1361, 272, 136, 62 and 21(i.e. for 1-day,
5-day, 10-day, 22-day and 66-day horizon)
3 Methodology and empirical model
In this section the information content of implied volatility and the forecasting
ability of volatility forecasts have been presented.
3.1 Univariate OLS and encompassing regression
The univariate OLS estimation presents the regression in which realized volatility [t
?1, t ? h] is regressed against one of the three competing volatility forecasts. The
OLS specification is
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rRV h;t ¼ p0 þ p1 rIVIX h;t þ ut ð9Þ

rRV h;t ¼ p0 þ p1 rRM h;t þ ut ð10Þ
rRV h;t ¼ p0 þ p1 rGJR h;t þ ut ð11Þ
In particular, the encompassing regression allows us to test the information
content of ex-post volatility at its lagged values (i.e. rRVt-1). The main rational of
performing encompassing regression is to compare the informational efficiency3 of
volatility forecast and predicative ability of historical return volatility (e.g.
Christensen and Prabhala 1998; Muzzioli 2013a). The encompassing regression is as
rRV h;t ¼ p0 þ p1 rIVIX h;t þ p2 rRV h;t1 þ ut ð12Þ
rRV h;t ¼ p0 þ p1 rRM h;t þ p2 rRV h;t1 þ ut ð13Þ
rRVh;t ¼ p0 þ p1 rGJRh;t þ p2 rRVh;t1 þ ut ð14Þ
Based on the above regression specifications we test the following hypotheses:
(a) Univariate regression: following the empirical work of Christensen and
Prabhala (1998) and Muzzioli (2012, 2013a, b) on the information content of
implied volatility, we can test the following three hypotheses:
1. if the volatility forecast subsumes some information about the future
volatility, then the slope p1 should be different from zero (i.e. p1 = 0).
2. if the volatility forecast is the unbiased estimate of future volatility then
intercept coefficient should not be different from zero and slope p1 should
not be different from unity (i.e. p0 = 0, p1 = 1). To test the joint
hypotheses Wald Chi square statistic has been calculated.
3. if implied volatility is efficient, then the residuals term ut should be white
noise and uncorrelated with the information set.
(b) Encompassing regression: this regression allows us to tests two hypotheses:
1. if the volatility forecast is an efficient forecaster of ex-post volatility, then
the slope coefficient of lagged realized volatility should not be different
from zero (i.e. p2 = 0).
2. the joint test of information content of volatility forecast is that ‘the slope
of lagged realized volatility is equal to zero’ and ‘the slope of volatility
forecast is one’ (i.e. p1 = 1, p2 = 0).
In addition, we analyze the performance of various volatility forecasts
combinations on realized volatility. The regression specification is
rRV h;t ¼ h0 þ h1 rIVIX h;t þ h2 rRM h;t þ ut ð15Þ
rRV h;t ¼ h0 þ h1 rIVIX h;t þ h2 rGJR h;t þ ut ð16Þ
rRV h;t ¼ h0 þ h1 rRM h;t þ h2 rGJR h;t þ ut ð17Þ
3
For example Füss (2005) and Joarder et al. (2013) explain the informational efficiency of Asian
emerging stock markets.
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We run the horserace between two volatility forecasts as the forecaster of

realized volatility. If both the slope (h1 and h2) are statistically significant then both
volatility forecasts can be used as the forecaster of realized volatility. If h1 is
statistically significant and h2 is not significant, then the volatility forecast with
slope h1 dominates the next one. The estimation results in the Eqs. 15–17 might be
affected by multicolinearity, hence we calculate VIF statistic between the pairs of
volatility forecasts (see ‘‘Appendix’’). The ‘‘Appendix’’ clearly shows that there is
no significant problem of multicolinearity in the augmented regressions except to
the regression for 66-day horizon; therefore we remove the regression results for
this forecast.
3.2 Instrumental variable estimation
The problem of EIV occurs due to violation of the assumption of no errors of

measurement. More specifically, measurement error causes: First, slope of the
explanatory variable remains downward biased, the intercept also overestimated
(i.e. upward biased) Second, when size of sample increased even though the
parameters remains asymptotically biased and inconsistent. In our case, we deal
with h-day forward-looking forecasts of implied volatility which is subject to
measurement error. The implied volatility is subject to measurement error due to
Non-synchronous trading of underlying, jumps, bid-ask spread, infrequent trading
and so on, hence rIVIX h,t cannot be measured absolutely accurately. Consequently,
two stage least squares method (2SLS) has been used with the aid of instrumental
variable estimation.4 In first stage OLS we obtain the fitted values of implied
volatility (rIVIX h,t) denoted as rÎVIXh;t (one period lagged values of rIVIX h,t is used to
calculate the fitted values of implied volatility).
First stage OLS

rÎVIX h;t ¼ u0 þ u1 þ rIVIX h;t1 þ et ð18Þ
Second Stage OLS
rRV h;t ¼ p0 þ p1 rÎVIX h;t þ ut ð19Þ
In 2SLS procedure, the fitted values of implied volatility as obtained in the first
stage OLS are replaced with original values in the second stage of regression.
Unlike the previous studies (e.g. Christensen and Nielsen 2006; Bandi and Perron
2006 and Barunik and Barunikova 2012) our study deals with the forecasts of
various volatility measures based on: implied volatility index, RiskMetrics and
GJR-GARCH for [t ? 1, t ? h] forward-looking horizon, in fact the volatility
forecast might be showing long memory and other time series characteristic. The
issue of long memory and fractionally cointegrating relation has been discussed by
Christensen and Nielsen (2006) and Barunik and Barunikova (2012), and they
suggested more appropriate method (e.g. narrow band least squares) should be
employed for the study of market efficiency rather than simple OLS.
4
For example, Swamy and Hall (2012) describe the instrumental variable estimation method in the
presence of measurement errors in the causality study.
123
3.3 Forecast evaluation
It is essential to calculate the forecasts evaluation as suggested by statisticians and

practiced in the literature. Table 7 reports root mean square error, mean absolute
error and Teil’s U statistic for the given realized volatility and the various
competing volatility forecasts.
The root mean square error (RMSE) is obtained as,
1X T
1X T
RMSE ¼ et ¼ ðr^t rt Þ2
T t¼1 T t¼1
The mean absolute error (MAE) is obtained as,
1X T
1X T
MAE ¼ jet j ¼ r^t rt
T t¼1 T t¼1
The Teil’s U statistic is written as,
PT
ðr^t rt Þ2
Teil’s U statistic ¼ PTt¼1 BM 2 , where BM is the bench market forecasts.
t¼1
ðr^t rt Þ
In addition, Diebold and Mariano (1995) test for pairwise forecasts has been
performed to determine the best candidate for the forecasting of stock market
volatility.
3.4 Summary statistics
In this section summary statistics has been presented for the various volatility
forecasts by presenting the graphical analysis, forecast evaluation and statistical
properties of forecasts of: implied volatility, RiskMetrics, GJR-GARCH with the
realized volatility. The summary statistics has been reported for both overlapping
and non-overlapping data points.
Figure 1 shows the time series plot of realized volatility of various time horizon
against different volatility forecasts (i.e. implied volatility, RiskMetrics, GJR-
GARCH). Panel A of the Fig. 1 shows the time series plot of realized volatility and
GJR-GARCH forecasts of 1-, 5-, 10-, 22- and 66-day forecasts horizon, similarly
Panel B and C shows the plot of realized volatility against implied volatility and
RiskMetrics forecasts. The bold line represents the realized volatility and the grey
scale line signifies volatility forecasts. The graphical view through 1- to 66-day
volatility forecasts seems to be in line with the realized volatility, but for several
observation volatility forecasts are very high as compare to realized volatility. This
happens due to the extreme nature of market during the financial crises took place in
year 2008–2009. The rest of the observation well explains the realized volatility.
The close observation of the plot of implied and realized volatility for different
time horizon; it is clearly visible that the forecasts of 5-, 10- and 22-day tracks quite
well to the realized returns volatility (see e.g. Giot 2002, 2005). The graphical
analysis reveals that the second most reliable forecast for the future volatility is
RiskMetrics. The gap between implied and realized volatility for several observa-
tion occurred due to the potential problem of measurement, this issue has been
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Fig. 1 Time series plot of various volatility forecasts against realized volatility
addressed in the following section using instrumental variable and two stage least
squares method.
Table 1 summarizes the statistical properties of various competing volatility
forecasts. The table reports the mean, maximum, minimum and standard deviation
for realized volatility and other forecasts of volatility. The results on statistical
properties clearly show that there are no major differences between overlapping and
non-overlapping data points. The average volatility forecasts of three competing
measures of 22-day horizon are respectively 6.86, 7.32 and 7.50, and the average of
corresponding realized volatility is found to be 7.13. This clearly shows that
volatility forecasts approaches to the future realized return volatility. The same
pattern is observed for non-overlapping data points. The statistic mean, maximum
and minimum explains that the forecast value is an increasing function of the h-day
forecasts horizon. One of the interesting result noticed from the standard deviation
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262
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Table 1 Summary statistics of various volatility forecasts
Statistics Realized volatility Implied volatility RiskMetrics GJR-GARCH
5-Day 10-Day 22-Day 66-Day 5-Day 10-Day 22-Day 66-Day 5-Day 10-Day 22-Day 66-Day 5-Day 10-Day 22-Day 66-Day
Panel A overlapping sampling (9100)

Mean 3.24 4.71 7.13 12.73 3.27 4.62 6.86 11.88 3.46 4.90 7.26 12.58 3.54 5.02 7.50 13.26
Max 16.93 19.13 25.24 31.17 10.03 14.19 21.04 36.45 10.72 15.17 22.49 38.96 13.61 18.03 24.64 32.94
Min 0.38 1.12 1.95 4.60 1.54 2.17 3.22 5.58 1.06 1.50 2.22 3.85 1.42 2.04 3.13 5.64
SD 2.21 2.94 4.12 6.55 1.31 1.86 2.75 4.77 1.85 2.62 3.89 6.74 1.92 2.69 3.93 6.44
Panel B non-overlapping sampling (9100)
Mean 3.25 4.70 7.13 12.52 3.28 4.59 6.78 11.61 3.47 4.89 7.40 12.48 4.63 18.58 9.35 36.80
Max 16.57 18.68 21.72 30.31 8.26 11.54 14.20 24.59 10.57 14.79 20.66 33.11 5.42 27.02 10.55 50.05
Min 0.55 1.21 2.45 5.09 1.57 2.28 3.22 6.29 1.09 1.60 2.85 5.27 3.58 5.24 7.92 18.49
SD 2.19 2.94 4.09 6.63 1.30 1.80 2.58 5.00 1.86 2.59 3.96 7.17 0.48 5.85 0.74 9.26
The table reports the descriptive statistics of various competing volatility forecasts estimated as the forecasts of realized volatility
that ex-post volatility is more variable than the ex-ante volatility forecasts; this kind
of results supports the studies of (Christensen and Prabhala 1998; Hansen 2001;
Christensen and Hensen 2002; Padhi and Shaikh 2014).5
4 Empirical results
This section presents the empirical results on the information content of implied
volatility for in-sample and out-of-sample framework. The estimation results are
reported using the univariate OLS, 2SLS and instrumental variable estimation. The
encompassing and horserace regression has been also estimated to test the
hypothesis of unbiasedness and efficiency of implied volatility, and the superiority
of various competing volatility forecasts.
Table 2 shows the estimation results on in-sample ARCH/GARCH model using
Eq. 2, the parenthesis reports z-statistic of robust standard errors consistent of
Bollerslev and Wooldridge (1992). The first row of the table gives the estimation
output for the standard GARCH(1,1) model, the slopes are respectively a = 0.09
and b1 = 0.91, this reveals strong persistence of volatility in explaining the market
volatility. The second row allows the information asymmetry term in which the
slope of GJR-GARCH model (b2 = 0.11) appeared positive and highly statistically
significant. This signifies that negative return shocks results into larger changes in
the volatility than the positive return shocks. The last column of the table reports the
log-likelihood of the respective models, by introducing asymmetry term the LL
increases by 14.55, this clears that by allowing information asymmetry the model
improves more than the previous one.
Third row shows the measurement of volatility in the residual shocks along with
market’s expected volatility. The estimation results (a = 0.04, c = 1.23, significant
at 1 % level) clearly show that implied volatility captures better persistency of stock
market volatility than the historical past returns. Moreover, the introduction of
lagged squared residual term does not add significantly in the log-likelihood. The
fourth row explains the market volatility in terms of market return shocks,
asymmetry and implied volatility, the estimated slopes show that implied volatility
(IVIX) dominates the past historical returns in explaining the volatility persistency.
The last row show the unrestricted version of Eq. 2, in which the estimates of
market shocks does not appears statistically significant. The slopes of variance and
asymmetry term appears to be significant, one can also see that implied volatility
still remains (c = 0.11) significant at 10 % level. The conditional volatility model
provides an insight that daily implied volatility also captures the persistence of stock
market volatility. The log-likelihood values also remains higher as compare to all
previous models. Moreover, introducing the exogenous factor reduces the slope of
variance equation in GARCH model.
Table 3 shows the regression analysis of information content of three competing
volatility forecasts of h-day horizon. This is an out-of-sample estimation which is
5
The ex-post volatility appears to be more variable because implied volatility is the smoothed
expectation of the ex-post realized return volatility (e.g. Christensen and Prabhala 1998).
123
264
123
Table 2 In-sample ARCH/GARCH framework
Model Estimate LL
x 9 104 a b1 b2 c
Omega ARCH GARCH GJR IVIX2t-1
GARCH 0.0142 (1.54) 0.0902a (4.74) 0.9096a (60.09) 3854.48

GJR-GARCH 0.0172 (1.59) 0.0359 (1.11) 0.9076a (63.32) 0.1114a (2.93) 3869.03
ARCH-IVIX -0.297 (-2.82) 0.0407 (1.04) 1.2368a (11.16) 3870.333
a
GJR-ARCH-IVIX 0.153 (1.16) -0.0214 (-2.29) 0.2593 (2.91) 0.7823a (6.00) 3857.40
GJR-GARCH-IVIX -0.0003 (-0.01) -0.0194 (-1.04) 0.8237a (20.39) 0.1933a (5.03) 0.1080c (1.87) 3901.18
2
The table reports the variants of in-sample ARCH.GARCH model of Eq. ht ¼ x þ þ b1 ht1 þ
a1 u2t1 þ
b2 It1 u2t1 IVIXt1 ,
the values in parentheses shows z-statistic,
consistent of robust standard errors of Bollerslev and Wooldridge (1992). The implied volatility is rescaled in daily volatility series
b
Significant at a 1, 5, c 10 % level
Table 3 Simple OLS estimation of realized volatility on various forecasts

Model p0 p1 Adj.R2 Wald v2 -stat
Volatility forecasts based on 1-day horizon

rIVIX -0.0022 (-1.84)c 0.9674 (9.99)a 0.20 103.38 [0.000]a
c a
rRM 0.0016 (1.75) 0.6688 (9.42) 0.19 204.94 [0.000]a
a
rGJR 0.0009 (1.21) 0.7032 (13.04) 0.22 227.26 [0.000]a
rIVIX -0.0067 (-1.96)b 1.1964 (9.31)a 0.53 6.84 [0.032]
c
rRM 0.0048 (1.75) 0.7981 (8.21)a 0.46 4.79 [0.090]
rGJR 0.1474 (7.42)a -2.4812 (-6.23)a 0.29 552.50 [0.000]a
rIVIX -0.0085 (-1.69)c 1.2105 (9.05)a 0.54 2.90 [0.233]
rRM 0.0087 (2.20)b 0.7826 (8.15)a 0.47 10.37 [0.005]a
rGJR 0.1012 (7.63)a -0.2918 (-5.04)a 0.33 5868.04 [0.000)a
rIVIX -0.006 (-0.86) 1.1513 (7.81)a 0.52 2.10 [0.349]
a
rRM 0.0198 (2.58) 0.6953 (6.12)a 0.44 10.01 [0.006]a
rGJR 0.4133 (6.17)a -3.6566 (-5.42)a 0.42 105.77 [0.000]a
rIVIX 0.0209 (0.97) 0.8983 (5.49)a 0.43 0.90 [0.639]
b
rRM 0.0504 (2.55) 0.5994 (5.43)a 0.38 6.13 [0.046]
rGJR 0.3271 (6.73)a -0.5488 (-4.88)a 0.56 863.10 [0.000]a
The table reports simple OLS estimation for the three competing volatility forecasts as the estimate of
future realized volatility for non-overlapping samples: The regression models are rRV h;t ¼ p0 þ
p1 rIVIX h;t þ ut ; rRV h;t ¼ p0 þ p1 rRM h;t þ ut and rRV h;t ¼ p0 þ p1 rGJR h;t þ ut . Wald v2 -stat tests the
null p0 ¼ 0; p1 ¼ 1. The parentheses shows t-statistic HAC consistent standard errors of Newey and West
Significant at a 1, b
5, c 10 % level
based on the ex-ante implied volatility and historical ex-post returns. Table 3 shows
the estimation output on non-overlapping data points, Christensen and Prabhala
(1998) point out that for overlapping samples estimates will suffer from problem of
autocorrelation, and the resulted estimates will be misleading. The estimation in the
presence of autocorrelation and hetroscedaticity significantly affects on the
fundamental properties of estimates.
The univariate regression results of Table 3 provides the two core insights: (1)
the implied volatility as the market’s expectation dominates the other volatility
forecasts; (2) by increasing forecasts horizon (h-day) the goodness of fit of model
improves, which implies that volatility forecasts approaches to the realized return
volatility as h-day horizon increases. The respective estimates of: implied volatility,
RiskMetrics and GJR-GARCH for 1-day horizon are 0.97, 0.67 and 0.70, all these
slopes appears statistically significant at 1 % level. The results indicate that all three
volatility forecasts contain the information to predict the future stock market
volatility, but the adj. R2 of the respective regression are very low. Consequently,
123
we consider some more basic regression of 5-, 10-, 22- and 66-day horizon. The
next four panels of Table 3 explains that implied volatility outperforms the other
volatility forecasts, the slope of implied volatility appears (1.20 = 5-day,
1.21 = 10-day n and 1.15 = 22-day horizon) very closer to unity. The regression
result clearly indicates that explanatory power increases for the longer forward-
looking horizon. Moreover, the second most competing measure as the forecast of
realized volatility is RiskMetrics.
Based on the theoretical framework presented in the previous section the
volatility forecasts can be unbiased and efficient forecasts of realized volatility if
and only if the intercept of the various model is not different from zero and the slope
of volatility forecasts is not different from the unity. In most of the regression the
intercept is not zero and slope is not equal to one, hence we reject the null p0 = 0,
p0 = 1, this implies that neither implied volatility nor RiskMetrics nor GJR-
GARCH appears to be unbiased estimates of future realized return volatility. But
based on the Wald v2-stat for implied volatility forecast (10-day and 22-day
horizon); it appears to be an unbiased estimate of realized volatility.
Table 4 reports the encompassing regression output in which we allow one
period lagged values of realized volatility as an additional regressor. The main
rationale is to test the efficiency of forecasted volatility measures. It has been clearly
observed from the Table 4, the lagged realized volatility does not improve the
model fit, and the lagged realized volatility appears to be insignificant for several
models of h-day horizon. In most of the cases the slopes of three competing
volatility forecasts appears to be more than the slope of lagged realized volatility.
This indicates that realized volatility do not add any valuable market wide
information to predict the future stock market volatility. Finally, for implied
volatility forecasts of 1-day, 10-day and 22-day horizon the slopes are respectively
0.94, 1.00 and 0.85, in which lagged realized volatility remains insignificant,
moreover the intercept is also not different from zero. At this stage the
encompassing results clearly describes that implied volatility forecasts outperform
the other volatility forecasts, and it is an unbiased and efficient forecasts of stock
market volatility. The Wald v2-stat in Table 4 clearly show that the null p1 = 1,
p2 = 0 cannot be rejected (for 1-,10-, 22 and 66-day horizon) hence implied
volatility is an unbiased and efficient forecast of realized volatility, and lagged
historical return volatility do not provide valuable information. The results of
univariate and encompassing regression are consistent with the studies of Giot
(2002, 2005) and Frijns et al. (2010a, b).
Table 5 reports the horserace regression in which we compare the performance of
three competing volatility forecasts among each other as the forecaster of future
realized return volatility. Using the combination of volatility forecasts increases the
adjusted R2 dramatically as compare to previous regressions. The first panel reports
the superiority of implied volatility against the RiskMetrics approach. It is clearly
seen that the slope of implied volatility for h-day horizon appears more than the
RiskMetrics and it appears statistically significant. In the later panels once again
implied volatility dominates GJR-GARCH forecasts, and in the last panel
RiskMetrics approach is better than the GJR-GARCH.
123
Table 4 Encompassing OLS estimation of Realized volatility on various forecasts

Model p0 p1 p2 Adj.R2 Wald v2 -stat

rIVIX -0.002 (-1.83)c 0.938 (9.37)a 0.029 (0.61) 0.19 1.5 [0.463]
c
rRM 0.001 (1.74) 0.636 (8.55)a 0.047 (0.98) 0.18 80.1 [0.000]a
rGJR 0.000 (0.95) 0.769 (10.93)a -0.076 (-1.74)c 0.23 77.2 [0.000]a
rIVIX -0.003 (-1.29) 0.855 (4.19)a 0.258 (1.79)c 0.53 22.2 [0.000]a
b a b
rRM 0.005 (2.42) 0.494 (4.99) 0.309 (2.44) 0.49 30.4 [0.000]a
a a a
rGJR 0.073 (4.24) -1.249 (-4.05) 0.512 (4.56) 0.49 408.3 [0.000]a
rIVIX -0.006 (-1.00) 1.004 (3.01)a 0.149 (0.68) 0.55 6.8 [0.033]
rRM 0.009 (2.98)a 0.513 (2.58)a 0.258 (1.08) 0.48 12.0 [0.000]a
rGJR 0.052 (3.62)a -0.154 (-3.32)a 0.497 (3.53)a 0.50 1788.7 [0.000]a
rIVIX -0.002 (-0.22) 0.850 (2.46)b 0.219 (0.97) 0.52 2.5 [0.276]
a
rRM 0.021 (3.04) 0.067 (0.24) 0.629 (2.56)b 0.46 12.3 [0.002]a
rGJR 0.238 (3.80)a -2.132 (-3.57)a 0.447 (4.37)a 0.54 107.9 [0.000]a
rIVIX 0.034 (1.91)c -0.163 (-0.36) 0.825 (2.10)b 0.45 2.5 [0.282]
c
rRM 0.026 (1.83) -0.315 (-0.63) 1.041 (1.87)c 0.46 10.4 [0.005]a
rGJR 0.226 (2.39)b -0.392 (-2.15)b 0.337 (2.01)b 0.58 190.9 [0.000]a
The table reports encompassing OLS estimation of Realized volatility on various forecasts for non-
overlapping samples: The regression models are rRV h;t ¼ p0 þ p1 rIVIX h;t þ p2 rRV h;t1 þ ut ; rRV h;t ¼
p0 þ p1 rRM h;t þ p2 rRV h;t1 þ ut and rRV h;t ¼ p0 þ p1 rGJR h;t þ p2 rRV h;t1 þ ut . Wald v2-stat tests the
null p1 = 1, p2 = 0. The parentheses shows t-statistic HAC consistent standard errors of Newey and
West
5, c 10 % level
Now starting with the forecasts of implied volatility over the RiskMetrics
approach, the regression results on h-day horizon, the adj. R2 = 0.54 is calculated
for the 10-day horizon in which the slope of implied volatility is 1.19 and the slope
of RiskMetrics forecasts is 0.02. For other h-day forecasts again implied volatility
outperformed the RiskMetrics. The next combination is implied volatility and GJR-
GARCH, in which implied volatility is more informative than the historical
conditional return volatility. The last panel explains the comparison of two ex-post
measure of historical returns as the forecasts of future volatility. The regression
analysis clearly indicates that RiskMetrics approach is the best forecaster of future
volatility than the GJR–GARCH forecasts of h-day horizon. The highest adj. R2 for
non-overlapping horserace regression is 0.60 (for implied volatility and GJR-
GARCH); this indicates that these two competing forecasts best explains the future
stock market volatility.
Moreover, in Table 5 the Wald Chi square statistic has been reported to test the
null h1 = 1, h2 = 0. The first panel of the table clearly explain that implied
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Table 5 Horserace OLS estimation of realized volatility on various forecasts

Model h0 h1 h2 Adj.R2 Wald v2-stat
Volatility forecasts: IVIX-RM

rRV 1-day -0.001 (-1.10) 0.632 (3.26)a 0.258 (1.84)c 0.20 3.7 [0.156]
a
rRV 5-day -0.005 (-1.31) 0.976 (2.82) 0.166 (0.69) 0.50 2.8 [0.236]
rRV 10-day -0.008 (-1.22) 1.185 (2.72)a 0.018 (0.07) 0.54 2.7 [0.258]
rRV 22-day -0.006 (-0.65) 1.137 (2.32)b 0.009 (0.03) 0.51 1.0 [0.589]
Volatility forecasts: IVIX-GJR
rRV 1-day -0.000 (-0.52) 0.258 (1.58) 0.549 (4.36)a 0.23 2031.1 [0.000]a
a
rRV 5-day 0.014 (0.74) 1.094 (6.35) -0.387 (-1.16) 0.51 4.5 [0.103]
rRV 10-day 0.013 (0.89) 1.043 (5.69)a -0.076 (-1.56) 0.55 6.7 [0.033]
rRV 22-day 0.172 (2.93)a 0.824 (5.18)a -1.683 (-3.09)a 0.56 9.7 [0.018]
rRV 66-day 0.228 (3.31)a 0.397 (2.54)b -0.405 (-1.14) 0.60 14.9 [0.001]a
Volatility forecasts: RM-GJR
rRV 1-day 0.001 (1.61) -0.157 (-1.47) 0.844 (8.21)a 0.23 1354.5 [0.000]a
c a
rRV 5-day 0.040 (1.95) 0.676 (5.05) -0.680 (-1.85) 0.47 5.873 [0.053]
rRV 10-day 0.035 (2.36)b 0.621 (4.40)a -0.104 (-2.08)b 0.49 7.2 [0.027]
rRV 22-day 0.234 (3.40)a 0.436 (3.33)a -2.090 (-3.24)a 0.51 18.9 [0.000]a
rRV 66-day 0.254 (3.65)a 0.232 (1.91)a -0.429 (-3.18)a 0.58 47.7 [0.000]a
The table reports Horserace OLS estimation of Realized volatility on various forecasts for non-over-
lapping samples: The regression models are rRV h;t ¼ h0 þ h1 rIVIX h;t þ h2 rRM h;t þ ut ; rRV h;t ¼ h0 þ
h1 rIVIX h;t þ h2 rGJR h;t þ ut and rRV h;t ¼ h0 þ h1 rRM h;t þ h2 rGJR h;t þ ut . Wald v2-stat tests the null
h1 = 1, h2 = 0. The parentheses shows t-statistic HAC consistent standard errors of Newey and West
5, c 10 % level
volatility forecast of all horizon perform better than the RiskMetrics forecasts, and
appears to be unbiased estimate of realized volatility. In particular, the second panel
of the table shows that implied volatility forecast with 5-day, 10-day and 22-day
horizon appears to be better than the GJR-GARCH forecasts. The last panel
indicates that RiskMetrics forecast with 5- and 10-day horizon dominates the GJR
forecast and remains unbiased estimate of realized return volatility.
Finally, at this point the slope of implied volatility appears approximately near to
unity and intercept remains insignificant. This empirical evidence provides an
insight that ex-ante forecasts contains good amount of market wide information to
explain the future stock market volatility. Moreover, the empirical evidence also
reported that implied volatility is the unbiased and efficient estimate of future
volatility.
Table 6 shows the 2SLS estimation results for the forecasts based on implied
volatility which is supposed to be measured with error. There are several sources of
measurement error discussed in the previous section, which causes the problem of
EIV. The RiskMetrics and GJR-GARCH forecasts are based on the stock index
returns while implied volatility is inverted from the observed option prices hence
implied volatility is subject to measurement error. In the presence of EIV, OLS
estimates remains inconsistent and 2SLS gives consistent estimates. The Hausman
123
Table 6 Instrumental variable/2SLS estimation of Realized volatility on various forecasts

Model Fitted values of rÎVIX
Forecast Horizon p0 p1 Adj.R2 H-statistic
rRV 1-day -0.002 (-2.27)b 0.997 (10.55)a 0.20 4.02 [0.044]

b
rRV 5-day -0.006 (-2.01) 1.178 (10.39)a 0.51 0.70 [0.393]
rRV 10-day -0.005 (-1.11) 1.142 (9.40)a 0.54 2.36 [0.123]
rRV 22-day -0.004 (-0.58) 1.127 (7.17)a 0.52 0.11 [0.732]
rRV 66-day -0.008 (-0.46) 1.139 (6.19)a 0.37 1.00 [316]
The table Instrumental variable/2SLS estimation of Realized volatility on various forecasts for non-
overlapping samples. H-statistic follows v2 -stat (1) and test the null ‘OLS estimates are more consistent
than 2SLS’. The parentheses shows t-statistic HAC consistent standard errors of Newey and West
5, c 10 level
H-stat for 22-day horizon of non-overlapping samples calculated 0.1165, which is

insignificant; hence OLS estimates are more consistent than the 2SLS. This
indicates that implied volatility forecast is free from measurement error.
For non-overlapping data points the estimate of implied volatility is calculated
1.14 with adj. R2 = 0.54, in this 2SLS regression the intercept appears to be
insignificant. The 2SLS estimation procedure indicates 10- day and 22-day forward-
looking forecasts are the best estimate of future realized volatility. In addition, the
intercept approaches to zero and slope of implied volatility is near to one, this
supports the null hypothesis that implied volatility is the unbiased estimate of future
stock market volatility.
4.1 Statistical properties of volatility forecasts
In the previous section we have discussed various measures of evaluation of

volatility forecasts. The calculated measure of evaluation for realized volatility
and volatility forecasts has been presented in the Table 7. The evaluation
statistics are presented for both overlapping and non-overlapping samples. The
comparison of the results of Tables 7 and 8 speaks the same outcome except to
the GJR-GARCH forecasts, in which the non-overlapping samples of 1-day and
66-day volatility forecast of GJR performs better than the other volatility
forecasts. In line with the results of non-overlapping samples the values of
RMSE and MAE appears to be minimum for 5-, 10- and 22-day forecasts
horizon for the implied volatility forecasts, but for RiskMetrics and GJR-
GARCH it remains highest. The Theil’s U-statistic also speaks the same story,
which shows minimum for all forward-looking horizon. The second best
candidate for the realized volatility is RiskMetrics which outperforms the GJR-
GARCH forecast. For more robust results Diebold and Mariano (1995) test has
been performed for the group of volatility forecasts. Table 8 reports the pairwise
comparison of various competing volatility forecasts using DM-test, the first
column of the table clearly show that implied volatility is the best candidate as
the forecast of realized return volatility for 1-day horizon. Moreover, one can see
123
Table 7 Forecasts evaluation\

Horizon Implied volatility RiskMetrics GJR-GARCH
RMSE MAE Theil’s U RMSE MAE Theil’s U RMSE MAE Theil’s U
Overlapping samples
1-day 0.0114 0.0076 0.4531 0.0115 0.0076 0.5045 0.0112 0.0075 0.5126
5-day 0.0160 0.0102 1.6747 0.0166 0.0105 1.7890 0.0131 0.0082 1.3504
10-day 0.0204 0.0128 3.0330 0.0214 0.0134 3.2676 0.0145 0.0090 2.0890
22-day 0.0288 0.0178 5.7014 0.0301 0.0189 5.9463 0.0162 0.0097 2.9176
66-day 0.0477 0.0338 14.7440 0.0485 0.0358 15.0310 0.0169 0.0099 4.2970
Non-overlapping samples
1-day 0.0114 0.0076 0.4531 0.0115 0.0076 0.5045 0.0112 0.0075 0.5126
5-day 0.0153 0.0099 0.8213 0.0160 0.0101 0.8556 0.0183 0.0122 1.1397
10-day 0.0197 0.0124 0.8052 0.0212 0.0130 0.8749 0.0238 0.0155 0.9785
22-day 0.0278 0.0177 0.9250 0.0300 0.0180 0.9938 0.0305 0.0210 1.1677
66-day 0.0476 0.0344 1.0785 0.0493 0.0364 1.0954 0.0415 0.0307 1.2093
The table reports the forecast evaluation based on RMSE, MAE and Teil’s U-statistic for the various
forecasts against realized volatility. The sample period consists of 11/01/20007/to 01/8301/2013.]
Table 8 Diebold and Mariano

RiskMetrics GJR-GARCH
test for pair wise comparison
1-day
Implied volatility -3.846 (0.000)a -1.724 (0.085)c
RiskMetrics – 1.357 (0.175)
5-day
Implied volatility -1.553 (0.121) -13.26 (0.000)a
RiskMetrics – -10.16 (0.000)a
10-day
22-day
The table shows Diebold and
Mariano tests (1995). The loss
function for competing forecasts RiskMetrics – -4.093 (0.000)a
is RMSE. Each cell presents 66-day
t-statistics and corresponding Implied volatility -0.8721 (0.393) -5.434 (0.000)a
p value in the parentheses
5, c 10 %
that t-statistic is negative but not significant in the rest of forecasts horizon; this
implies that implied volatility and RiskMetrics forecasts are equally important in
stock market volatility assessment. The last column of Table 8 explains that
implied volatility is the first best measures of volatility forecast and the second
best candidate is RiskMetrics, and third GJR-GARCH forecast. At this point we
can conclude that implied volatility is the forward-looking expectation of future
123
realized volatility, and dominates the traditional historical return volatility

forecasts.
The measures of forecasts evaluation and DM-test signifies that expected
volatility is the best estimate of future realized return volatility, this also clears that
implied volatility provides the best market wide information to explain the future
volatility of next h-day. Our results are consistent with the empirical work reported
by Giot (2002, 2003, 2005), and this prima facie evidences motivates that forecasts
based on the options trading, outperforms the forecast based on the historical return
of short and medium forecast horizon.
5 Conclusions and practical implication
The present study analyzes the information content of implied volatility and the
other competing volatility forecasts. The study uncovers the relationship between
ex-ante and ex-post volatility forecasts of various h-day (i.e. 1-, 5-, 10-, 22- and
66-day) forecast horizon. We have been computed the volatility forecasts using
implied volatility index (IVIX), RiskMetrics and GJR-GARCH of historical stock
index returns. The analysis has been presented in in-sample and out-of-sample
volatility framework. More than 5 years data points of the period 11/01/2007 to
04/30/2013 has been considered for daily close of India VIX and S&P Nifty stock
index.
The in-sample (ARCH/GARCH) forecast has been explained strong persistence
of volatility in explaining the stock market volatility. The nested ARCH/GARCH
forecasts clearly explain that implied volatility outperforms the historical index
residuals. Hence, the in-sample volatility forecasts signifies that past squared returns
do not add significant information what already contained in the lagged implied
volatility.
To analyze the information content of competing volatility forecasts, the
univariate regression has explained that implied volatility outperforms the other
volatility forecasts. The implied volatility forecasts of 10-day and 22-day horizon
appear to be more informative with the highest adjusted R2. Moreover, the second
most considerable forecast is the RiskMetrics. Apparently, the univariate regression
shows that IVIX’s slope is very close to unity; hence it appears as an unbiased
estimate of future stock market volatility.
The encompassing regression has shown that lagged realized volatility do not add
significant market wide information to explain the future volatility. The empirical
evidences on univariate and encompassing regression conclude that implied
volatility dominates the other volatility forecasts, and it is the unbiased and
efficient forecaster of stock market volatility. In addition, the instrumental variable
estimation clarifies that implied volatility is not measured with the errors and OLS
estimates are more consistent than the 2SLS.
There are several practical implication of the study for investors, financial
institutions and authorities making decisions on the regulation of stock markets
(SEBI, Securities and Exchange Board of India).
123
1. The implied volatility is useful in the forecasting of future realized volatility as

the forward-looking measure.
2. Investment decisions like assets valuation, covered call writing, portfolio
management. The implied volatility index is the expected volatility of 30 days
horizon of future stock market volatility; hence the study enables to compute
the short run expectation (say, 5-day, 10-day, 22-day horizon) of the underlying
assets.
3. The study holds an important implication for the portfolio analysts; those are
investing from the Asia and pacific region in the emerging markets like India.
4. Implied volatility index (India VIX) is the investors fear-gauge index for the
Indian capital market that provide signal to the volatility traders and policy
makers (SEBI- Securities and Exchange Board of India and RBI-Reserve Bank
of India).
5. Particularly, the information content of implied volatility index is an important
study that have the implication on derivatives pricing (i.e. Futures and Options)
written on the stock index and volatility index.
6. The market efficiency of implied volatility based on the emerging market’s
volatility index (India VIX) motivates the other emerging stock markets to
construct the implied volatility indices in order to gauge the investor’s
expectation about the future volatility. This kind of study also encourages the
NSE (National Stock Exchange of India) to start some volatility products (like
F&Os) on India VIX to allow more market liquidity and transparency.
Acknowledgments Authors thank the anonymous reviewers for helpful suggestions and comments that
significantly improved the quality of the paper. Special thanks are due to the Editor-in-Chief for
communicating the editorial decision timely.
Appendix
See Table 9.
Table 9 VIF test (variance

Horizon Implied volatility- Implied volatility- RiskMetrics-
inflation factors)
RiskMetrics GJR-GARCH GJR-GARCH
1-day 6.215 4.373 8.453

5-day 6.955 2.010 1.908
10-day 7.190 1.626 1.701
If VIF-statistics is more than 10, 22-day 6.838 1.869 1.804
than there is a chance of 66-day 13.661 1.800 1.774
multicolinearity
123
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Shaikh Padhi 2014 The Forecasting Performance of Implied Volatility Index Evidence From India VIX

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Econ Change Restruct (2014) 47:251–274

The forecasting performance of implied volatility index:

Imlak Shaikh • Puja Padhi

Abstract In this paper, we investigate the forecasting performance of ex-post an

Keywords Information content Ex-ante and ex-post volatility IVIX

JEL Classification C53 G14

I. Shaikh (&) P. Padhi

implied volatility impound significant information to explain future volatility as the

2 Data sources and volatility forecast

2.1 Data sources

dates. The implied volatility might be subject to measurement error; hence we

2.2 Forecasting ability of implied volatility

2.2.1 Implied volatility in ARCH/GARCH-type models

The empirical studies on implied volatility index in ARCH/GARCH type

2.2.2 The measures of volatility forecast

2.2.2.2 RiskMetrics forecasts The RiskMetrics model for volatility on date t is

2.2.2.4 Realized volatility Giot (2005) suggest the following specification to

where Rt = ln(Niftyt/Niftyt-1), rRV h,t is the ex-post return volatility calculated at

3 Methodology and empirical model

3.1 Univariate OLS and encompassing regression

rRV h;t ¼ p0 þ p1 rIVIX h;t þ ut ð9Þ

We run the horserace between two volatility forecasts as the forecaster of

3.2 Instrumental variable estimation

The problem of EIV occurs due to violation of the assumption of no errors of

First stage OLS

3.3 Forecast evaluation

It is essential to calculate the forecasts evaluation as suggested by statisticians and

3.4 Summary statistics

Panel A overlapping sampling (9100)

GARCH 0.0142 (1.54) 0.0902a (4.74) 0.9096a (60.09) 3854.48

Table 3 Simple OLS estimation of realized volatility on various forecasts

Volatility forecasts based on 1-day horizon

Table 4 Encompassing OLS estimation of Realized volatility on various forecasts

Volatility forecasts based on 1-day horizon

Table 5 Horserace OLS estimation of realized volatility on various forecasts

Volatility forecasts: IVIX-RM

Table 6 Instrumental variable/2SLS estimation of Realized volatility on various forecasts

Forecast Horizon p0 p1 Adj.R2 H-statistic

rRV 1-day -0.002 (-2.27)b 0.997 (10.55)a 0.20 4.02 [0.044]

H-stat for 22-day horizon of non-overlapping samples calculated 0.1165, which is

4.1 Statistical properties of volatility forecasts

In the previous section we have discussed various measures of evaluation of

Table 7 Forecasts evaluation\

RMSE MAE Theil’s U RMSE MAE Theil’s U RMSE MAE Theil’s U

Table 8 Diebold and Mariano

realized volatility, and dominates the traditional historical return volatility

5 Conclusions and practical implication

1. The implied volatility is useful in the forecasting of future realized volatility as

Table 9 VIF test (variance

1-day 6.215 4.373 8.453

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