On the predictability of model-free implied correlation

This paper investigates the existence of predictable patterns in the evolution of the implied correlation series. To this end, alternative time-series specifications are employed to model the correlation dynamics, and the statistical and economic significance of out-of sample forecasts is assessed. The statistical measures provide strong evidence in favor of predictable patterns in the S&P 100 options market. A trading strategy designed to exploit daily changes in the series can yield abnormal profits; however, these profits disappear when transaction costs are incorporated. We conclude that the efficient market hypothesis cannot be rejected.