Volume 14 | Issue 1 | Article 2
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Forecasting Accuracy of Implied and GARCH-Based Probability Density Functions
Recent research has investigated the ability of option-implied densities to produce unbiased forecasts of the actual price densities of some financial assets. In this paper, for the first time, we assess the incremental predictive power of option-implied density forecasts to that of standard GARCH-based density forecasts. Density forecasts are estimated for both currency and index futures contracts. We find that, once option-implied densities have been adjusted to account for the presence of a risk premium, their forecasting performance is very similar to that of historical-based density forecasts. Also, our results indicate that special attention should be devoted to the tails of the distributions, too often extrapolated through parametric specifications.
