Wednesday, June 15, 2011

Implied vs Realized volatility premium

There is a funny thing that I've come across while trying to build a volatility model. According to my estimations the VIX is usually higher than the actual volatility (RV)  realized for that same period. Just take a look at the following chart:
In the top chart I've plotted the VIX (IV) and RV estimate for a 3-year period. The bottom chart is the difference between the IV & RV . To estimate the RV I've used a function from  tradingwithmatlab blog. It uses several common estimators for RV (I've used the average value for RV ).
It looks like IV on average  is 7% higher than the RV. So one could just sell volatility and get a steady profit, right? Knowing that there is no free lunch in trading, it seems that I'm missing out something. Is my estimation of RV incorrect? Is it unjustified to compare VIX and SP500 volatility? All feedback is very welcome...