Biases in Implied Volatilities

There's a pretty substantial literature on biases in analyst's earnings forecasts. They usually define bias as a difference between the last estimated forecast of earnings and actual earnings. Here's a somewhat related paper - on errors in implied volatility estimates. In their paper "Implied and Realized Volatility in the Cross-Section of Equity Options" Manuel Ammann, David Skovmand and Michael Verhofen examine whether implied volatilites differ systematically from realized vlatilities, and whether those differences are related to firm risk (beta) size (market cap),growth opportunities (market/book), and momentum. Here's the abstract:

Using a complete sample of US equity options, we analyze patterns of implied volatility in the cross-section of equity options with respect to stock characteristics. We find that high-beta stocks, small stocks, stocks with a low-market-to-book ratio, and non-momentum stocks trade at higher implied volatilities after controlling for historical volatility. We find evidence that implied volatility overestimates realized volatility for low-beta stocks, small caps, low-market-to-book stocks, and stocks with no momentum and vice versa. However, we cannot reject the null hypothesis that implied volatility is an unbiased predictor of realized volatility in the cross section.

Read the whole thing here.

HT: CXO Advisory Group

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