Does implied volatility of currency futures option imply volatility of exchange rates?
AbstractBy investigating currency futures options, this paper provides an alternative economic implication for the result reported by Stein [Overreactions in the options market, Journal of Finance 44 (1989) 1011–1023] that long-maturity options tend to overreact to changes in the implied volatility of short-maturity options. When a GARCH process is assumed for exchange rates, a continuous-time relationship is developed. We provide evidence that implied volatilities may not be the simple average of future expected volatilities. By comparing the term–structure relationship of implied volatilities with the process of the underlying exchange rates, we find that long-maturity options are more consistent with the exchange rates process. In sum, short-maturity options overreact to the dynamics of underlying assets rather than long-maturity options overreacting to short-maturity options.
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Bibliographic InfoArticle provided by Elsevier in its journal Physica A: Statistical Mechanics and its Applications.
Volume (Year): 374 (2007)
Issue (Month): 2 ()
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Option; Implied volatility; GARCH;
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