LAUSR

We test the price discovery of the term structure of implied volatilities, and investigate its implications on the out-of-sample forecast of implied volatility. Both long-maturity and short-maturity options are important for the price discovery of the implied volatility curve. Long-maturity options contain more information although they are much less traded than short-maturity options. This is probably because long-maturity implied volatilities are more associated with a persistent long-term variance factor. Out-of-sample forecast analysis shows that the implied volatility curve information is useful for the out-of-sample forecast of implied volatilities up to one week ahead. Short-maturity implied volatilities tend to be more predictable than long-maturity implied volatilities. Trading strategies based on the predictability of implied volatilities could generate significant risk-adjusted returns after controlling for transaction costs. Our results are consistent with option pricing models with component volatilities.