Title: Dynamic interaction between historical and implied volatility in the Indian option market

Authors: T. Viswanathan; R. Sriram; Prathana Mukherjee

Addresses: Symbiosis Institute of Business Management, Constituent of Symbiosis International (Deemed University), 95/1, 95/2, Electronics City, Phase 1, Hosur Road, Bengaluru, Karnataka 560100, India ' Symbiosis Institute of Business Management, Constituent of Symbiosis International (Deemed University), 95/1, 95/2, Electronics City, Phase 1, Hosur Road, Bengaluru, Karnataka 560100, India ' Symbiosis Institute of Business Management, Constituent of Symbiosis International (Deemed University), 95/1, 95/2, Electronics City, Phase 1, Hosur Road, Bengaluru, Karnataka 560100, India

Abstract: Forecasting volatility plays a key role while trading in the futures and options market. An accurate estimate of future volatility would facilitate the traders to determine the intrinsic value of options. In the spot market, volatility is estimated based on the variance of historical returns. However, the volatility of stocks and market indices in the options market is estimated based on implied volatility. This paper investigates the dynamic interaction of historical volatility and the market estimate of future volatility, which is termed as implied volatility (IV). We examine the performance of the Nifty index options' implied volatility and determine its power to predict future market volatility. The study is based on the implied volatility of Nifty call and put index options for the period between 2010 and 2018. We apply the co-integration test to examine the causal relationship between the historical and implied volatility. We apply ARIMA and GARCH models to examine the forecasting ability of implied volatility. The results of the study indicate that implied volatility has the power to predict future volatility of market returns.

Keywords: historical volatility; implied volatility; volatility forecast; ARIMA; generalised autoregressive conditional heteroscedasticity; GARCH.

DOI: 10.1504/IJPSPM.2021.117719

International Journal of Public Sector Performance Management, 2021 Vol.8 No.1/2, pp.128 - 144

Received: 02 Apr 2019
Accepted: 31 Oct 2019
Published online: 22 Sep 2021 *

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