[Implied volatility is widely believed to be informationally superior to historical volatility, because it is the "market's" forecast of future volatility. But for S&P 100 index options, the most actively traded contract in the United States, we find implied volatility to be a poor forecast of subsequent realized volatility. In aggregate and across subsamples separated by maturity and strike price, implied volatility has virtually no correlation with future volatility, and it does not incorporate the information contained in recent observed volatility.]

This paper issues a warning that compounding daily returns of the Center for Research in Security Prices (CRSP) equal-weighted index can lead to surprisingly large biases. The differences between the monthly returns compounded from the daily tapes and the monthly CRSP equal-weighted indices is almost 0.43 percent per month, or 6 percent per year. This difference amounts to one-third of the average monthly return, and is large enough to reverse the conclusions of a paper using the daily tape to compute the return on the benchmark portfolio. We also investigate the sources of these biases and suggest several alternative strategies to avoid them.

Implied volatility is widely believed to be informationally superior to historical volatility, because it is the “market’s” forecast of future volatility. But for S&P 100 index options, the most actively traded contract in the United States, we find implied volatility to be a poor forecast of subsequent realized volatility. In aggregate and across subsamples separated by maturity and strike price, implied volatility has virtually no correlation with future volatility, and it does not incorporate the information contained in recent observed volatility.

This paper issues a warning that compounding daily returns of the Center for Research in Security Prices (CRSP) equal‐weighted index can lead to surprisingly large biases. The differences between the monthly returns compounded from the daily tapes and the monthly CRSP equal‐weighted indices is almost 0.43 percent per month, or 6 percent per year. This difference amounts to one‐third of the average monthly return, and is large enough to reverse the conclusions of a paper using the daily tape to compute the return on the benchmark portfolio. We also investigate the sources of these biases and suggest several alternative strategies to avoid them.