The optimal corridor for implied volatility: From periods of calm to turmoil

Corridor implied volatility is obtained from model-free implied volatility by truncating the integration domain between two barriers. Empirical evidence on volatility forecasting in various markets points to the utility of trimming the risk-neutral distribution of the underlying stock price, in order to obtain unbiased measures of future realized volatility. The aim of this paper is to investigate the optimal corridor of strike prices for volatility forecasting in the Italian market, by analyzing numerous symmetric and asymmetric corridors in a dataset for the years 2005-2010 spanning both a relatively calm period and a period of turmoil. The results indicate that put prices, providing information on the probability of a downturn of the underlying asset, provide the best indication of future realized volatility, particularly in a period of turmoil.