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

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Author Info
Elizaveta Krylova () (European Central Bank, Market Operations, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany)
Jussi Nikkinen () (University of Vaasa, Department of Accounting and Finance, P.O. Box 700, 65101 Vaasa, Finland)
Sami Vähämaa () (University of Vaasa, Department of Accounting and Finance, P.O. Box 700, 65101 Vaasa, Finland)

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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.

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Paper provided by European Central Bank in its series Working Paper Series with number 530.

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Length: 46 pages
Date of creation: Sep 2005
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Handle: RePEc:ecb:ecbwps:20050530

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Related research
Keywords: Implied volatility; volatility term structure; foreign exchange options.;

Find related papers by JEL classification:
F31 - International Economics - - International Finance - - - Foreign Exchange
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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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.:
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    Other versions:
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  8. Daniel A. Dias & Carlos Robalo Marques & João M. C. Santos Silva, 2005. "Time or state dependent price setting rules? Evidence from Portuguese micro data," Working Paper Series 511, European Central Bank. [Downloadable!]
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