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A volatility smile-based uncertainty index

Author

Listed:
  • José Valentim Machado Vicente

    (Central Bank of Brazil)

  • Jaqueline Terra Moura Marins

    (Central Bank of Brazil)

Abstract

We propose a new uncertainty index based on the discrepancy of the smile of FX options. We show that our index spikes near turbulent periods, forecasts economic activity and its innovations hold a significant and negative equity premium. Unlike other uncertainty indexes, our index is supported by equilibrium models, which relate the difference of options prices across moneyness to uncertainty. Moreover, our index is based on investment decisions, can be easily and continuously updated and is comparable across countries.

Suggested Citation

  • José Valentim Machado Vicente & Jaqueline Terra Moura Marins, 2021. "A volatility smile-based uncertainty index," Annals of Finance, Springer, vol. 17(2), pages 231-246, June.
    • Handle: RePEc:kap:annfin:v:17:y:2021:i:2:d:10.1007_s10436-021-00384-6
    DOI: 10.1007/s10436-021-00384-6
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    More about this item

    Keywords

    Uncertainty; FX option; Volatility smile; Risk;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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