Forecasting realized volatility: The role of implied volatility, leverage effect, overnight returns, and volatility of realized volatility

We examine the role of implied volatility, leverage effect, overnight returns and volatility of realized volatility in forecasting realized volatility by extending the heterogeneous autoregressive (HAR) model to include these additional variables. We find that implied volatility is important in forecasting future realized volatility. In most cases a model that accounts for implied volatility provides a significantly better forecast than more sophisticated models that account for other features of volatility, but exclude the information backed out from option prices. This result is consistent over time. We also assess whether leverage effect, overnight returns and volatility of realized volatility carry any incremental information beyond that captured by implied volatility and past realized volatility. We find that while overnight returns and leverage e˙ect are important for some markets, the volatility of realized volatility is of limited value for most stock markets.