REIT Sector Implied Volatility Index: Liquidity and Information of Option Trading

Abstract

An accurate volatility forecast is essential in financial investments and risk management. Existing literature finds that the implied volatility from options trading best predicts the realized volatility in various financial products. In 2016, real estate was added to the S&P 500 as the eleventh sector; however, a reliable implied volatility measure for the real estate sector has not been developed yet. The existing literature in real estate investment trusts (REITs) relies primarily on insufficient volatility forecasts, such as implied volatility for a broader market or time series analysis. In this research, we develop a REIT sector implied volatility index derived from options on the US Real Estate exchange-traded fund, IYR. As Whaley, the creator of the VIX (implied volatility on S&P 500), points out, enough liquidity in option trading is critical in developing an implied volatility index. This study shows that IYR option trading is liquid enough and informative that our REIT sector implied volatility index outperforms other volatility forecast measures. Our findings suggest that the REIT sector implied volatility index from option trading data can be utilized in future research and industry risk management.