IDEAS home Printed from https://ideas.repec.org/h/wsi/wschap/9789812812599_0012.html
   My bibliography  Save this book chapter

A Test Of Efficiency For The Currency Option Market Using Stochastic Volatility Forecasts

In: Quantitative Analysis In Financial Markets Collected Papers of the New York University Mathematical Finance Seminar

Author

Listed:
  • DAJIANG GUO

    (Centre Solutions, Zurich Group, One Chase Manhattan Plaza, New York, NY 10005, USA and Institute for Policy Analysis, University of Toronto, Toronto, Canada, M5S 3G6, Canada)

Abstract

The conditional volatility of foreign exchange rates can be predicted with GARCH models, and with implied volatility extracted from currency options. This paper investigates whether the difference in these predictions is economically meaningful. In an efficient market, after accounting for transaction costs and risk, no trading strategy should earn abnormal risk-adjusted returns. In the absence of transaction costs, both the delta-neutral and the straddle trading strategies lead to significant positive economic profits against the option market, regardless of which volatility prediction method is used. The agent using the Implied Stochastic Volatility Regression method (ISVR) earns larger profits than the agent using the GARCH method. However, after accounting for transaction costs assumed to equal one percent of market prices, observed profits are not significantly different from zero in most trading strategies; the exception is for an agent using the ISVR method with a 5% price filter.

Suggested Citation

  • Dajiang Guo, 1999. "A Test Of Efficiency For The Currency Option Market Using Stochastic Volatility Forecasts," World Scientific Book Chapters, in: Marco Avellaneda (ed.), Quantitative Analysis In Financial Markets Collected Papers of the New York University Mathematical Finance Seminar, chapter 12, pages 292-311, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789812812599_0012
    as

    Download full text from publisher

    File URL: https://www.worldscientific.com/doi/pdf/10.1142/9789812812599_0012
    Download Restriction: Ebook Access is available upon purchase.
    File URL: https://www.worldscientific.com/doi/abs/10.1142/9789812812599_0012
    Download Restriction: Ebook Access is available upon purchase.
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:wsi:wschap:9789812812599_0012. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Tai Tone Lim (email available below). General contact details of provider: http://www.worldscientific.com/page/worldscibooks .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.