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Forecasting Exchange Rate Volatility in the Presence of Jumps

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Author Info

  • Thomas Busch

    ()
    (Danske Bank and CREATES)

  • Bent Jesper Christensen

    ()
    (University of Aarhus and CREATES)

  • Morten Ørregaard Nielsen

    ()
    (Queen's University and CREATES)

Abstract

We study measures of foreign exchange rate volatility based on high-frequency (5-minute) $/DM exchange rate returns using recent nonparametric statistical techniques to compute realized return volatility and its separate continuous sample path and jump components, and measures based on prices of exchange rate futures options, allowing calculation of option implied volatility. We find that implied volatility is an informationally efficient but biased forecast of future realized exchange rate volatility. Furthermore, we show that log-normality is an even better distributional approximation for implied volatility than for realized volatility in this market. Finally, we show that the jump component of future realized exchange rate volatility is to some extent predictable, and that option implied volatility is the dominant forecast of the future jump component.

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File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_1187.pdf
File Function: First version 2005
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Bibliographic Info

Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1187.

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Length: 37 pages
Date of creation: Dec 2005
Date of revision:
Handle: RePEc:qed:wpaper:1187

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Related research

Keywords: bipower variation; currency options; exchange rates; implied volatility; jumps; realized volatility;

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References

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Citations

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Cited by:
  1. Chan, Kam Fong & Gray, Philip & van Campen, Bart, 2008. "A new approach to characterizing and forecasting electricity price volatility," International Journal of Forecasting, Elsevier, vol. 24(4), pages 728-743.
  2. Thomas Busch & Bent Jesper Christensen & Morten Ørregaard Nielsen, 2008. "The Role of Implied Volatility in Forecasting Future Realized Volatility and Jumps in Foreign Exchange, Stock, and Bond Markets," Working Papers 1181, Queen's University, Department of Economics.
  3. Bunčák, Tomáš, 2013. "Jump Processes in Exchange Rates Modeling," MPRA Paper 49882, University Library of Munich, Germany.
  4. Thomas Busch & Bent Jesper Christensen & Morten Ørregaard Nielsen, 2006. "The Information Content of Treasury Bond Options Concerning Future Volatility and Price Jumps," Working Papers 1188, Queen's University, Department of Economics.

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