Financial decision makers often consider the information in currency option valuations when making assessments about future exchange rates. The purpose of this paper is to systematically assess the quality of option based volatility and density forecasts. We use a unique dataset consisting of over 10 years of daily data on over-the-counter currency option prices. We find that the OTC implied volatilities provide largely unbiased and fairly accurate forecasts of 1-month and 3-month ahead realized volatility. Furthermore, we find that the 1-month option implied density forecasts are well calibrated for the centre of the distribution but we find evidence of misspecification in the tail density forecasts. * Corresponding author: peter.christoffersen@mcgill.ca. We would like to thank the Editors (Rene Garcia and Ruey Tsay) and two anonymous referees for very helpful comments. We have benefited from several visits to the External Division of the European Central Bank whose hospitality is gratefully acknowledged. Very useful comments were also provided by Torben Andersen, Lorenzo Cappiello, Olli Castren, Bruce Lehmann, Filippo di Mauro, Stelios Makrydakis, Nour Meddahi and Neil Shephard. The OTC volatilities used in this paper were provided by Citibank N.A. The usual disclaimer applies.
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