Estimation of the Black-Scholes implied volatility term structure of Equity Warrants listed on the JSE: A comparison of volatility measures

The study examines the ability of three volatility-forecasting models to estimate the term structure of implied volatilities. The tests are performed on equity Warrants listed on the JSE with the three measures being the Generalized Autoregressive Conditional Heteroscedicity (GARCH), the exponential GARCH (EGARCH) and the Exponentially Weighted Moving Average (EWMA). The Black-Scholes implied volatility is assumed to reflect the market’s view. The results show that all three methods are unable to forecast the term structure at the 5% significance level but that they are able to indicate future trends. Further, the Black-Scholes model fails to identify an implied volatility under some market conditions thus making benchmarking the models difficult. A conclusion is reached that for the bounds of the study, the three models are not usable if short-term investment decisions need to be taken.