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Abstract

This paper presents a mixture multiplicative error model with a time-varying probability between regimes. We model the implied volatility derived from call and put options on the USD/EUR exchange rate. The daily first difference of the USD/EUR exchange rate is used as a regime indicator, with large daily changes signaling a more volatile regime. Forecasts indicate that it is beneficial to jointly model the two implied volatility series: both mean squared errors and directional accuracy improve when employing a bivariate rather than a univariate model. In a two-year out-of-sample period, the direction of change in implied volatility is correctly forecast on two thirds of the trading days.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 23721.

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Date of creation: Dec 2008
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Handle: RePEc:pra:mprapa:23721

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Related research

Keywords: Implied volatility; option markets; multiplicative error models; forecasting;

Find related papers by JEL classification:

• C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models
• C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
• G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

References

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