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Brexit and foreign exchange market expectations: Could it have been predicted?

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  • Nikola Gradojevic

    (University of Guelph
    University of Novi Sad)

Abstract

In order to gauge foreign exchange market expectations prior to and after the Brexit vote in June, 2016, this paper examines European options written on the GBP/USD and GBP/EUR exchange rates in 2016. First, the parameter estimates from a non-parametric option pricing model with a homogeneity hint show that the Brexit announcement was to a certain extent expected because the implicit probability density functions were negatively skewed in January–February, 2016 and April–June, 2016. This effect was more pronounced for the GBP/USD exchange rates, indicating an increased pessimism of the U.S. currency traders relative to their European counterparts. Entropic risk measures based on skewness premia of deepest out-of-the-money options confirm the findings from implicit distributions. Moreover, these new risk measures are found to statistically significantly predict foreign exchange market volatility at daily to monthly time horizons.

Suggested Citation

  • Nikola Gradojevic, 2021. "Brexit and foreign exchange market expectations: Could it have been predicted?," Annals of Operations Research, Springer, vol. 297(1), pages 167-189, February.
    • Handle: RePEc:spr:annopr:v:297:y:2021:i:1:d:10.1007_s10479-020-03582-z
    DOI: 10.1007/s10479-020-03582-z
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