2 Data
This study is based upon data relating to the SfcP 500 Composite Index, from
2 January 1990 to 17 October 2003 (3481 observations). To relate to the results
of Becker, Clements and White (2006), the same sample period is considered
here. To address the research question at hand, estimates of both IV and future
actual volatility are required.
The VIX index constructed by the Chicago Board of Options Exchange
from SfcP 500 index options constitutes the estimate of IV utilised in this
paper. It is derived from out-of-the-money put and call options that have ma-
turities close to the target of 22 trading days. For technical details relating
to the construction of the VIX index, see Chicago Board Options Exchange
(CBOE, 2003). While the true process underlying option pricing is unknown,
the VIX is constructed to be a general measure of the market’s estimate of
average SfcP 500 volatility over the subsequent 22 trading days (BPT, 2001,
Christensen and Prabhala, 1998 and CBOE, 2003). Having a fixed forecast
horizon is advantageous and avoids various econometric issues. This index has
only been available since September 2003 when the CBOE replaced a previous
implied volatility index based on SfcP 100 options1. It’s advantages in com-
parison to the previous implied volatility index is that it no longer relies on
option implied volatilities derived from Black-Scholes option pricing models, it
is based on more liquid options written on the SfcP500 and is easier to hedge
against (CBOE, 2003).
1The new version of the VIX has been calculated retrospectively back to January 1990,
the beginning of the sample considered here.