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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?

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    $\begingroup$ It depends what you are trying to do; if you are hedging an exotic option, price it with implied vols so you have accurate hedge trades. If you are trying to profit from vanilla mispricings, use historical vol. However, even in that case, it sometimes makes sense to use IV. See: math.ku.dk/~rolf/Wilmott_WhichFreeLunch.pdf $\endgroup$
    – experquisite
    Oct 27, 2015 at 3:42
  • $\begingroup$ @experquisite, the link is dead. $\endgroup$
    – Richard Hardy
    Nov 21 at 10:08
  • $\begingroup$ Could try googling Wilmott Which Free Lunch $\endgroup$
    – experquisite
    Nov 22 at 13:15

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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

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    $\begingroup$ As this is all about providing resource, a link to a specific paper would be much better. $\endgroup$
    – SRKX
    Oct 27, 2015 at 2:46
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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.

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  • $\begingroup$ Without even a brief summary of the paper, this reads more like a comment than an answer. $\endgroup$
    – Richard Hardy
    Nov 21 at 11:12
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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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  • $\begingroup$ Interesting, is there a study employing such methodology? $\endgroup$
    – berkorbay
    Mar 20, 2016 at 14:49

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