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2004•RePEc: Research Papers in EconomicsOpen access

Option Implied and Realised Measures of Variance

Damien P.G. Lynch, Nikolaos Panigirtzoglou

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Abstract

This paper analyses the differences between forward (risk-neutral expectation) and realised variance.Four different assets are examined: S&P 500, FTSE 100, eurodollar and short sterling futures.Model-free measures of risk-neutral forward variance are estimated using the full cross section of option prices of a given maturity.Intra-day futures data are used in the estimation of realised variance.A mean squared error criterion is devised to inform the choice of optimal intra-day frequency.Market microstructure issues are considered for both equity and interest rate futures markets.The bias and efficiency of forward variance as a predictor of realised variance is reexamined.

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This paper analyses the differences between forward (risk-neutral expectation) and realised variance.Four different assets are examined: S&P 500, FTSE 100, eurodollar and short sterling futures.Model-free measures of risk-neutral forward variance are estimated using the full cross section of option prices of a given maturity.Intra-day futures data are used in the estimation of realised variance.A mean squared error criterion is devised to inform the choice of optimal intra-day frequency.Market microstructure issues are considered for both equity and interest rate futures markets.The bias and efficiency of forward variance as a predictor of realised variance is reexamined.

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Available abstract

This paper analyses the differences between forward (risk-neutral expectation) and realised variance.Four different assets are examined: S&P 500, FTSE 100, eurodollar and short sterling futures.Model-free measures of risk-neutral forward variance are estimated using the full cross section of option prices of a given maturity.Intra-day futures data are used in the estimation of realised variance.A mean squared error criterion is devised to inform the choice of optimal intra-day frequency.Market microstructure issues are considered for both equity and interest rate futures markets.The bias and efficiency of forward variance as a predictor of realised variance is reexamined.

Key concepts: Variance risk premium, Futures contract, Variance swap, Variance (accounting), Econometrics, Price variance, Realized variance, Economics

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