Implied or historical vol as a forecast

Question

As a predictor of volatility over an option's remaining life, which is better: implied volatility or historical volatility?

Short answer

Implied volatility, generally. It is forward-looking and includes everything the market knows, including scheduled events, and empirical studies find it outperforms historical estimates. It is biased upward, though, because sellers demand a volatility risk premium, so the best forecasts often combine both.

Adapted from Crack, Heard on the Street, Q2.50, p.31; question and answer rewritten by SelfMadeQuant.com.

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Lessons behind this question

Reading the Implied Vol Surface — Moneyness, Term Structure, and Quoting Conventions

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