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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)

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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://www.econ.queensu.ca/working_papers/papers/qed_wp_1187.pdf
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Publisher 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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Find related papers by JEL classification:
C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General
F31 - International Economics - - International Finance - - - Foreign Exchange
G1 - Financial Economics - - General Financial Markets

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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    Other versions:
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  27. Charles Quanwei Cao & Gurdip S. Bakshi & Zhiwu Chen, 1997. "Empirical Performance of Alternative Option Pricing Models," Yale School of Management Working Papers ysm54, Yale School of Management. [Downloadable!]
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Full references

Cited by:
(explanations, 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.)

  1. 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. [Downloadable!]
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