The Forecasting Power of the Volatility Index in Emerging Markets: Evidence from the Taiwan Stock Market

Abstract

This paper explores the predictive power of the volatility index (VIX) in emerging markets from December 2006 to March 2010. The results of the study show that the models including both the volatility indicator and the option market information have a stronger predictive power. The predictive power of the models is improved by 88% in explaining the future volatility of stock markets, much better than that of other models merely considering the volatility indicator. With respect to the trading information from different types of investors in option markets, the trading information from the foreign institutional investors in option markets demonstrates a significantly positive relationship with the stock market volatility. In addition, the results of this paper also reveal that the volatility index (TVIX) of Taiwan stock index options is a strong indicator of future stock market volatility. The TVIX outperforms the historical volatility and the GARCH volatility forecast in assessing the activities of Taiwan's stock market.

Forecasting Stock Return Volatility: A Comparison of GARCH, Implied Volatility, and Realized Volatility Models

“…However, Giot () concludes that combining GARCH with implied volatility often improves on the results from either one alone. Carr and Wu, () for the S&P500 stock index, Yu et al, () using stock index options traded over‐the‐counter and on exchanges in Hong Kong and Japan and Yang and Liu, () for the Taiwan stock index reach similar conclusions. Frijns, Tallau, and Tourani‐Rad (), for the Australian index, find that at short horizons combining GJR‐GARCH and IV improve future volatility forecast, but overall IV outperforms the RiskMetrics and GJR‐GARCH.…”

The information content of implied volatility index (India VIX)

“…López and Navarro (2012) in their review paper describe that volatility indices outperform in the prediction of future volatility, and they show that volatility index can be considered as investor's-fear-gauge of fear of their portfolio. Yang and Liu (2012) investigates the predictive power of TVIX implied volatility index in the Taiwan stock market, they show that implied volatility index also hold the predictive power to forecast the future market volatility like the implied volatility of call and put options and they conclude that TVIX is an effective indicator of future volatility in the emerging markets. The studies (Daigler and Rossi 2006;Konstantinidia et al 2008;Szado 2009;Chung et al 2011;Konstantinidi and Skiadopoulos 2011;Shu and Zhang 2012) have demonstrated the informational efficiency of implied volatility index and shown that volatility products (say VIX F&Os) are helpful in the price discovery and portfolio risk management.…”

Cross-border exchanges and volatility forecasting

“…The first such index launched was the CBOE VIX in the US, which, according to Simons (2003), indicates how much market participants are willing to pay in terms of implied volatility to hedge stock portfolios with the S&P 500 index put options or to go long by buying S&P 500 index call options. Fleming et al (1995) found that the VIX performs better in forecasting future volatility in the US than other historical measures, with Carr and Wu (2006), Yu et al, (2010) and Yang and Liu (2012) reaching similar conclusions.…”