The Volatility Risk Premium Embedded in Currency Options

Low, Buen Sin; Zhang, Shaojun

doi:10.1017/s0022109000001988

Cited by 45 publications

(36 citation statements)

References 34 publications

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“…First, we are not testing whether implied volatility is an unbiased predictor of future realized volatility (e.g., Jorion, 1995). As a result, we do not examine the volatility risk premium documented by the literature on the implied-realized volatility relation (e.g., Coval and Shumway, 2001;Bakshi and Kapadia, 2003;Low and Zhang, 2005;Carr and Wu, 2009;and Christo¤ersen, Heston and Jacobs, 2010). Instead, we focus on the spot-forward implied volatility relation and the volatility term premium that characterizes this distinct relation.…”

Section: Introductionmentioning

confidence: 99%

Spot and forward volatility in foreign exchange

Corte

Sarno

Tsiakas

2011

Journal of Financial Economics

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This is the unspecified version of the paper.This version of the publication may differ from the final published version. Abstract This paper investigates the empirical relation between spot and forward implied volatility in foreign exchange. We formulate and test the forward volatility unbiasedness hypothesis, which may be viewed as the volatility analogue to the extensively researched hypothesis of unbiasedness in forward exchange rates. Using a new data set of spot implied volatility quoted on over-thecounter currency options, we compute the forward implied volatility that corresponds to the delivery price of a forward contract on future spot implied volatility. This contract is known as a forward volatility agreement. We …nd strong evidence that forward implied volatility is a systematically biased predictor that overestimates movements in future spot implied volatility. This bias in forward volatility generates high economic value to an investor exploiting predictability in the returns to volatility speculation and indicates the presence of predictable volatility term premiums in foreign exchange. Permanent repository link

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Section: Introductionmentioning

confidence: 99%

Spot and forward volatility in foreign exchange

Corte

Sarno

Tsiakas

2011

Journal of Financial Economics

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“…6 See Day and Lewis (1992), Canina and Figlewski (1993), Jorion (1995), Figlewski (1997), Fleming (1998), Christensen andPrabhala (1998), andHentschel (2003). 7 See Low and Zhang (2005) for a detailed description of the practices and conventions of the OTC currency option market.…”

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confidence: 99%

Who knows more about future currency volatility?

Charoenwong

Jenwittayaroje

Low

2009

Journal of Futures Markets

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to compare the predictive power of the implied volatility derived from currency option prices that are traded on the Philadelphia Stock Exchange (PHLX), Chicago Mercantile Exchange (CME), and over-the-counter market (OTC). Among the competing implied volatility forecasts, OTC-implied volatility subsumes the information content of PHLX-and CME-implied volatility. Consistent with extant studies our result also shows that the implied volatility provides more information about future volatility-regardless of whether it is from the OTC, PHLX, or CME markets-than time series based volatility.

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“…The same is true for Sarwar (2001) in an investigation of foreign exchange options traded on the Philadelphia Stock Exchange. However, Low and Zhang (2005) find risk premia in OTC foreign exchange options. Based on calibrations, Bates (1996b) argues that it is 'unlikely that the risk neutral and actual parameters would deviate substantially.'…”

Section: Using Options To Recover the Risk-neutral Pdf And Its Momentsmentioning

confidence: 98%

Option prices, exchange market intervention, and the higher moment expectations channel: a user's guide

et al. 2007

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A vast literature on the effects of sterilized intervention by the monetary authorities in the foreign exchange markets concludes that intervention systematically moves the spot exchange rate only if it is publicly announced, coordinated across countries, and consistent with the underlying stance of fiscal and monetary policy. Over the past 15 years, researchers have also attempted to determine if intervention has any effects on the dispersion and directionality of market views concerning the future exchange rate. These studies usually focus on the variance around the expected future exchange rate-the second moment. In this paper we demonstrate how to use over-the-counter option prices to recover the risk-neutral probability density function (PDF) for the future exchange rate. Using the yen|dollar exchange rate as an example, we calculate measures of dispersion and directionality, such as variance and skewness, from estimated PDFs to test whether intervention by the Japanese Ministry of Finance during the period 1996-2004 had any impact on the higher moments of the exchange rate. We find little or no systematic effect, consistent with the findings of the literature on the spot rate as: Japanese intervention was not publicly announced prior to August 2000, and since that time only publicly announced after the fact, over the past 10 years rarely coordinated across countries and, in hindsight, probably inconsistent with the underlying stance of monetary policy. Copyright © 2007 John Wiley & Sons, Ltd.

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The Volatility Risk Premium Embedded in Currency Options

Cited by 45 publications

References 34 publications

Spot and forward volatility in foreign exchange

Spot and forward volatility in foreign exchange

Who knows more about future currency volatility?

Option prices, exchange market intervention, and the higher moment expectations channel: a user's guide

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