Implied Versus Historical Volatility in Option Pricing and Forecasting
Summary
The discussion asks whether implied volatility (IV) produces better option prices than historical volatility (HV), noting that the common forward-looking argument for IV is not enough by itself to establish better pricing performance. It cites an experiment in a GARCH option valuation study that found no significant difference in price estimation performance between IV- and HV-based approaches, despite using different model parameters.
The replies point to research on the IV–HV signal, including studies of delta-hedged straddles, as evidence that IV may predict future realized volatility better than a contemporaneous HV measure. They also distinguish the information each measure can provide: HV can inform estimates of volatility variation, while IV reflects market pricing of risk and can be used to construct scenarios. These are brief pointers rather than a systematic literature review; the replies do not establish that IV always outperforms HV for option valuation or trading.
Key ideas
- The forward-looking nature of implied volatility alone does not prove it yields more accurate option prices.
- One cited experiment reports no significant price-estimation difference between implied- and historical-volatility approaches.
- Research on the IV–HV spread in delta-hedged straddles examines implied volatility's predictive value for future realized volatility.
- Historical volatility can help describe volatility variation, while implied volatility reflects market pricing of risk.
- The discussion offers research leads but no comprehensive comparison or universal conclusion.
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# Historical Volatility vs Implied Volatility Performance in Pricing Options # Historical Volatility vs Implied Volatility Performance in Pricing Options I consistently read on academic papers, when pricing options, using implied volatility is better than using historical volatility. Because, market is more "forward-looking" and historical data is "backward-looking". But I see little evidence for the statement in research papers. Actually the only experiment I encountered is part of an article Which GARCH Model for Option Valuation? They also say that implied volatility is better since it is forward looking but in one section they do a small experiment also with historical data. Their conclusion is, even though model parameters are different there is no significant difference in price estimation performance. Do you know about any other research on implied vs historical volatility performance on option pricing? ## Answer by phubaba (score 3) https://quant.stackexchange.com/a/21454 There is a lot of literature on the predictive power of IV - HV signal on detla hedged straddles for example. Where HV could be a variety of historical measures. I think there is a goyal and soretto? 2009 paper, and many others that cite it. This would mostly say that iv is predictive of more hv than the current hv measurement. Add the link: looks like I had it right from memory. http://www.utdallas.edu/~axs125732/CrossOptionsJFE.pdf ## Answer by Alex C (score 1) https://quant.stackexchange.com/a/21455 There are some old papers on this such as Fleming (1998) http://www.ruf.rice.edu/~jfleming/pub/jef9810.pdf sorry I don't know the recent litterature. ## Answer by Flib (score 1) https://quant.stackexchange.com/a/24680 Use HV to get the volatility of the HV. extrapolate it to the current IV in order to build scenarios for different deltas and you have a good resource. So HV is a good indicative to see the probable oscillation of your IV and the IV itself gives you the market risk sentiment. You can see also how your volatility behaviors in different levels, usually the Vol of HV is higher in the HV high-band.
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