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Using Implied Volatility to Estimate Forward CAPM Beta

Article Quant Q&A · Author: sparkle
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Summary

The document asks whether forward-looking volatility estimates can improve an estimate of an asset’s CAPM beta for the coming month. The proposed approach replaces historical market variance with VIX-implied volatility and historical asset volatility with the implied volatility of a one-month at-the-money call on the asset. It retains a statistically estimated correlation between the asset and the market, combining correlation with the two volatility estimates to represent covariance.

The answer says this is a better approach and points to a figure in a cited research paper as support. However, the excerpt supplies no details from that figure, no estimation procedure for the correlation, and no performance measures or caveats. It therefore presents a plausible forward-looking estimation idea, but the limited evidence shown is insufficient to establish that the method will reliably improve next-month beta forecasts across assets or market conditions.

Key ideas

  • CAPM beta can be expressed using asset-market covariance divided by market variance.
  • The proposed forecast combines implied volatility estimates with an estimated asset-market correlation.
  • The method uses VIX for market volatility and a one-month at-the-money option for asset volatility.
  • The brief answer endorses the approach by citing research, but provides no results or implementation details.

Tags

EquitiesOptionsVolatilityFactor investingStatistics
Full text
# Estimate Beta of CAPM from Implied Volatility?


# Estimate Beta of CAPM from Implied Volatility?












In the CAPM theory Beta of asset $i$ are estimated in this way:

$ \beta_i = \frac{\sigma_{im}}{\sigma^2_m} $ where $\sigma_{im} = \rho_{im} \sigma_i \sigma_m$

But all these data are historical data. So, I'm wondering what if I use

- $\sigma^2_m$ <- Implied volatility of SP500 (VIX)

- $\sigma_{im}$ <- implied volatility for the asset $i$ using the at-the-money call option with a 1-month maturity.

- $\rho_{im}$ will be statistically estimated.

This way is a better estimation of the $\beta_{i}$ for the next month?

## Answer by phdstudent (score 14, accepted)

https://quant.stackexchange.com/a/22100

Yes it is a better way. Just take a look to figure 3, from Buss and Vilkov (2012, RFS):

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.