The Model-Free Implied Volatility And Its Information Content

Volatility is a very important variable in finance and economy, and the forecasting of volatility has always held the attention of academics and practitioners.An important technique to forecast volatility is implied volatility. The traditional implied volatility is obtained by the price of options through Black-Sholes' option pricing model, i.e. BS implied volatility. Due to the incorrect assumptions of the BS option pricing model, the BS implied volatility can't subsume all the information contained in options.In this paper, it is the first time to use model-free implied volatility, which was derived by Britten-Jones and Neuberger(2000), to study information content contained in Hang Seng Index (HSI) options. Compared with the BS implied volatility, the model-free volatility is independent of any option pricing model, and it extracts information from options across all strike prices, thus it is more efficient in forecasting volatility.The study on the HSI options suggests that the model-free implied volatility contains most information among the historical volatility, the BS implied volatility and the GARCH volatility, and subsumes all information contained in the past realized volatility, which means the HSI option market is efficient, and is a more efficient forecast for future realized volatility. It is also found that when the forecasting horizon is one month, the model-free volatility can also subsumes the information contained in BS implied volatility, while for two month, it's not true, but the mode-free volatility still subsumes the most information. It is found that only when the trading volume of HSI options is large enough and the strike price is diversified enough, that the model-free implied volatility is more efficient than the BS implied volatility. Too much extrapolation will decrease the forecasting ability of the model-free volatility, and a more appropriate method to calculate the model-free volatility is given in this paper. At last, volatility risk premium is not found in HIS option market.