Advanced Search
MyIDEAS: Login

Cross-dynamics of volatility term structures implied by foreign exchange options

Contents:

Author Info

  • Krylova, Elizaveta
  • Nikkinen, Jussi
  • Vähämaa, Sami

Abstract

This paper examines the cross-dynamics of volatility term structures implied by foreign exchange options. The data used in the empirical analysis consist of daily observations of implied volatilities for OTC options on the euro, Japanese yen, British pound, Swiss franc, and Canadian dollar, quoted against the U.S. dollar. The empirical findings demonstrate that two common factors can explain a vast proportion of the variation in volatility term structures across currencies. Furthermore, the results indicate that the euro is the dominant currency, as the implied volatility term structure of the euro is found to affect all the other volatility term structures, while the term structure of the euro appears to be virtually unaffected by the other currencies. Finally, our results reveal a rather deviant relation between the volatility term structures of the euro and Swiss franc by providing evidence of significant nonlinearities in the relationship between these two currencies. JEL Classification: E52, E58, F33, F40

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp530.pdf
Download Restriction: no

Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 0530.

as in new window
Length:
Date of creation: Sep 2005
Date of revision:
Handle: RePEc:ecb:ecbwps:20050530

Contact details of provider:
Postal: Postfach 16 03 19, Frankfurt am Main, Germany
Phone: +49 69 1344 0
Fax: +49 69 1344 6000
Web page: http://www.ecb.europa.eu/home/html/index.en.html
More information through EDIRC

Order Information:
Postal: Press and Information Division, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany
Email:

Related research

Keywords: foreign exchange options; implied volatility; volatility term structure;

Other versions of this item:

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Inagaki, Kazuyuki, 2007. "Testing for volatility spillover between the British pound and the euro," Research in International Business and Finance, Elsevier, vol. 21(2), pages 161-174, June.
  2. Calvet, Laurent E. & Fisher, Adlai J. & Thompson, Samuel B., 2006. "Volatility comovement: a multifrequency approach," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 179-215.
  3. Malik, Ali Khalil, 2005. "European exchange rate volatility dynamics: an empirical investigation," Journal of Empirical Finance, Elsevier, vol. 12(1), pages 187-215, January.
  4. Detken, Carsten & Hartmann, Philipp, 2000. "The euro and international capital markets," CFS Working Paper Series 2000/09, Center for Financial Studies (CFS).
  5. Nikkinen, Jussi & Sahlstrom, Petri & Vahamaa, Sami, 2006. "Implied volatility linkages among major European currencies," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 16(2), pages 87-103, April.
  6. Kearney, Colm & Patton, Andrew J, 2000. "Multivariate GARCH Modeling of Exchange Rate Volatility Transmission in the European Monetary System," The Financial Review, Eastern Finance Association, vol. 35(1), pages 29-48, February.
  7. Robert Mundell, 1998. "What the euro means for the dollar and the international Monetary system," Atlantic Economic Journal, International Atlantic Economic Society, vol. 26(3), pages 227-237, September.
  8. Eui Jung Chang & Benjamin Miranda Tabak, 2007. "Are implied volatilities more informative? The Brazilian real exchange rate case," Applied Financial Economics, Taylor & Francis Journals, vol. 17(7), pages 569-576.
  9. Pesaran, M. H. & Shin, Y., 1997. "Generalised Impulse Response Analysis in Linear Multivariate Models," Cambridge Working Papers in Economics 9710, Faculty of Economics, University of Cambridge.
  10. Garman, Mark B. & Kohlhagen, Steven W., 1983. "Foreign currency option values," Journal of International Money and Finance, Elsevier, vol. 2(3), pages 231-237, December.
  11. Wang, Alan T., 2007. "Does implied volatility of currency futures option imply volatility of exchange rates?," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 374(2), pages 773-782.
  12. Bollen, Nicolas P. B & Rasiel, Emma, 2003. "The performance of alternative valuation models in the OTC currency options market," Journal of International Money and Finance, Elsevier, vol. 22(1), pages 33-64, February.
  13. Detken, Carsten & Hartmann, Philipp, 2000. "The euro and international capital markets," Working Paper Series 0019, European Central Bank.
  14. Alfonso Novales & Emilio Domínguez, 2002. "A factor model of term structure slopes in eurocurrency markets," Documentos del Instituto Complutense de Análisis Económico 0224, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales.
  15. Abad, Pilar & Novales, Alfonso, 2005. "An error correction factor model of term structure slopes in international swap markets," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 15(3), pages 229-254, July.
  16. Heynen, Ronald & Kemna, Angelien & Vorst, Ton, 1994. "Analysis of the Term Structure of Implied Volatilities," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 29(01), pages 31-56, March.
  17. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  18. Sanjiv R. Das & Rangarajan K. Sundaram, 1998. "Of Smiles and Smirks: A Term-Structure Perspective," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-024, New York University, Leonard N. Stern School of Business-.
  19. Campa, Jose Manuel & Chang, P H Kevin, 1995. " Testing the Expectations Hypothesis on the Term Structure of Volatilities in Foreign Exchange Options," Journal of Finance, American Finance Association, vol. 50(2), pages 529-47, June.
  20. Kim, Minho & Kim, Minchoul, 2003. "Implied volatility dynamics in the foreign exchange markets," Journal of International Money and Finance, Elsevier, vol. 22(4), pages 511-528, August.
  21. Hiro Y. Toda & Peter C.B. Phillips, 1991. "Vector Autoregression and Causality," Cowles Foundation Discussion Papers 977, Cowles Foundation for Research in Economics, Yale University.
  22. Mark Rubinstein., 1994. "Implied Binomial Trees," Research Program in Finance Working Papers RPF-232, University of California at Berkeley.
  23. Stein, Jeremy, 1989. " Overreactions in the Options Market," Journal of Finance, American Finance Association, vol. 44(4), pages 1011-23, September.
  24. Campa, J.M. & Chang, P.H.K., 1995. "The Forecasting Ability of Correlations Implied in Foreign Exchange Options," Papers 95-26, Columbia - Graduate School of Business.
  25. Angela Black & David McMillan, 2004. "Long run trends and volatility spillovers in daily exchange rates," Applied Financial Economics, Taylor & Francis Journals, vol. 14(12), pages 895-907.
  26. Ederington, Louis H. & Lee, Jae Ha, 1996. "The Creation and Resolution of Market Uncertainty: The Impact of Information Releases on Implied Volatility," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(04), pages 513-539, December.
  27. Speight, Alan E. H. & McMillan, David G., 2001. "Volatility spillovers in East European black-market exchange rates," Journal of International Money and Finance, Elsevier, vol. 20(3), pages 367-378, June.
  28. Peter Christoffersen & Stefano Mazzotta, 2005. "The Accuracy of Density Forecasts from Foreign Exchange Options," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 3(4), pages 578-605.
  29. Rubinstein, Mark, 1994. " Implied Binomial Trees," Journal of Finance, American Finance Association, vol. 49(3), pages 771-818, July.
  30. Helmut Frisch, 2003. "The euro and its consequences: What makes a currency strong?," Atlantic Economic Journal, International Atlantic Economic Society, vol. 31(1), pages 15-31, March.
  31. Mixon, Scott, 2007. "The implied volatility term structure of stock index options," Journal of Empirical Finance, Elsevier, vol. 14(3), pages 333-354, June.
  32. Fung, Hung-Gay & Patterson, Gary A., 1999. "Volatility linkage among currency futures markets during US trading and non-trading periods," Journal of Multinational Financial Management, Elsevier, vol. 9(2), pages 129-153, March.
  33. Bonser-Neal, Catherine & Tanner, Glenn, 1996. "Central bank intervention and the volatility of foreign exchange rates: evidence from the options market," Journal of International Money and Finance, Elsevier, vol. 15(6), pages 853-878, December.
  34. repec:att:wimass:9204 is not listed on IDEAS
  35. Soku Byoun & Chuck C. Y. Kwok & Hun Y. Park, 2003. "Expectations Hypothesis of the Term Structure of Implied Volatility: Evidence from Foreign Currency and Stock Index Options," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 1(1), pages 126-151.
  36. Xu, Xinzhong & Taylor, Stephen J., 1994. "The Term Structure of Volatility Implied by Foreign Exchange Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 29(01), pages 57-74, March.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Inagaki, Kazuyuki, 2007. "Testing for volatility spillover between the British pound and the euro," Research in International Business and Finance, Elsevier, vol. 21(2), pages 161-174, June.
  2. Äijö, Janne, 2008. "Implied volatility term structure linkages between VDAX, VSMI and VSTOXX volatility indices," Global Finance Journal, Elsevier, vol. 18(3), pages 290-302.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:ecb:ecbwps:20050530. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Official Publications).

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.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with 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 profile, as there may be some citations waiting for confirmation.

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