Recovering Implied Volatility
Published Online:26 Jan 2023https://doi.org/10.1287/mnsc.2022.4653
Abstract
We propose a methodology for estimating option-implied, forward-looking variances and covariances of assets and portfolios, which may not possess actively traded options. Our approach relies on the observation that, if asset returns follow a factor structure, then the variances and covariances of the factors span the systematic variances and covariances of assets. We implement the methodology empirically and show that our forward-looking moment estimates provide useful implications for the prediction of jumps and for portfolio choice.
This paper was accepted by Gustavo Manso, finance.
Supplemental Material: The online appendix and data are available at https://doi.org/10.1287/mnsc.2022.4653.
