Conclusions

In this paper we employ volatility forecasts to evaluate the profitability of option trading strategies. We first present several volatility models theoretically and then use these specifications to empirically evaluate the efficiency of the Bund future options market. It turns out that volatility forecasts based on historical returns are capable of adding value when used together with simple trading rules. We derive profits for several different variations of the trading rule and find in all cases abnormal returns.

Our results need some qualifications, however. Firstly, our analysis is based on closing prices, at which actual trades cannot be executed. Therefore the profitability of the simple trading rules critically depends on how far the closing prices come to those price at which the last trades of a day are carried out. Secondly, our results clearly indicate that during periods of low volatility the forecasting model does not perform very well. Only if there is sufficient volatility clustering, so that a GARCH model is very accurate in predicting conditional variances, our trading rule can outperform the market.

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