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Volatility Smile and One‐Month Foreign Currency Volatility Forecasts

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  • Alfred Huah‐Syn Wong
  • Richard A. Heaney

Abstract

We find knowledge of the volatility smile implied from foreign exchange options improves foreign exchange volatility forecast accuracy. The literature shows curvature of the smile can be captured by risk‐neutral skewness and risk‐neutral kurtosis and we find inclusion of these variables in forecast models improves volatility forecast accuracy. Further, delta‐neutral hedged portfolio performance highlights the economic significance of incorporating knowledge of the smile in forecast models. Analysis is conducted using options with one month to maturity written on four exchange rate series, GBP/USD, EUR/USD, AUD/USD, and the USD/JPY from 2001 to 2006. © 2016 Wiley Periodicals, Inc. Jrl Fut Mark 37:286–312, 2017

Suggested Citation

  • Alfred Huah‐Syn Wong & Richard A. Heaney, 2017. "Volatility Smile and One‐Month Foreign Currency Volatility Forecasts," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 37(3), pages 286-312, March.
    • Handle: RePEc:wly:jfutmk:v:37:y:2017:i:3:p:286-312
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    Cited by:

    1. Reus, Lorenzo & Carrasco, José A. & Pincheira, Pablo, 2020. "Do it with a smile: Forecasting volatility with currency options," Finance Research Letters, Elsevier, vol. 34(C).
    2. Dicle, Mehmet F. & Levendis, John, 2020. "Historic risk and implied volatility," Global Finance Journal, Elsevier, vol. 45(C).
    3. Wong, Alfred, 2019. "Currency jumps, Euribor-OIS spreads and the volatility skew: A study on the dollar-euro crash risk of 2007–2015," Finance Research Letters, Elsevier, vol. 29(C), pages 7-16.

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