those we have discussed so far. Both embed IV as an additional explanatory variable in a GARCH model of stock price volatility (or EGARCH, in the case of DL). That is, the model combines both historical price information and IV in computing the volatility parameter for the current period. Both papers take great care to minimize the effects of nonsynchronous trading and the other sources of noise in computing IV's. Both focus essentially on extracting information about volatility from IV, not on testing whether IV is an efficient forecast by itself. There is therefore no requirement that the model's forecasting horizon match the maturity of the options from which the IV is derived: LL build models of daily price volatility for 10 individual stocks while DL look at volatility of the OEX index over a 1 week horizon. While each paper contains a great deal of interesting analysis, most relevant to our investigation here is that both find that IV contributes a statistically significant amount of information about volatility at the horizon covered by the models, but they also find that IV does not fully impound the information that the model is able to extract from historical prices. LL also examine forecasting volatility through option expiration and find that IV alone is less accurate than the models using historical prices in 8 out of 10 cases. This subsection has brought out some of the problems in testing the joint hypothesis that implied volatility is the market's volatility forecast and that this forecast is the true expected value of volatility conditional on the market's information. We have also seen that the evidence reported in the well-known published studies of this hypothesis is weaker than we would like it to be. We will now go on to examine implied volatility from OEX index options using a methodology that corrects for some, though not all, of the problems we have raised. III. Data and Methodology The data sample is drawn from the set of closing prices for all call options on the S&P 100 index (OEX) from March 15, 1983, shortly after index option trading opened, through March 28,
those we have discussed so far. Both embed IV as an additional explanatory variable in a GARCH model of stock price volatility (or EGARCH, in the case of DL). That is, the model combines both historical price information and IV in computing the volatility parameter for the current period. Both papers take great care to minimize the effects of nonsynchronous trading and the other sources of noise in computing IV's. Both focus essentially on extracting information about volatility from IV, not on testing whether IV is an efficient forecast by itself. There is therefore no requirement that the model's forecasting horizon match the maturity of the options from which the IV is derived: LL build models of daily price volatility for 10 individual stocks while DL look at volatility of the OEX index over a 1 week horizon. While each paper contains a great deal of interesting analysis, most relevant to our investigation here is that both find that IV contributes a statistically significant amount of information about volatility at the horizon covered by the models, but they also find that IV does not fully impound the information that the model is able to extract from historical prices. LL also examine forecasting volatility through option expiration and find that IV alone is less accurate than the models using historical prices in 8 out of 10 cases. This subsection has brought out some of the problems in testing the joint hypothesis that implied volatility is the market's volatility forecast and that this forecast is the true expected value of volatility conditional on the market's information. We have also seen that the evidence reported in the well-known published studies of this hypothesis is weaker than we would like it to be. We will now go on to examine implied volatility from OEX index options using a methodology that corrects for some, though not all, of the problems we have raised. III. Data and Methodology The data sample is drawn from the set of closing prices for all call options on the S&P 100 index (OEX) from March 15, 1983, shortly after index option trading opened, through March 28,