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Forecasting Exchange Rate Volatility in the Presence of Jumps

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  • Busch, Thomas
  • Jesper Christensen, Bent
  • Orregaard Nielsen, Morten

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.

Suggested Citation

  • Busch, Thomas & Jesper Christensen, Bent & Orregaard Nielsen, Morten, 2005. "Forecasting Exchange Rate Volatility in the Presence of Jumps," Queen's Economics Department Working Papers 273664, Queen's University - Department of Economics.
    • Handle: RePEc:ags:quedwp:273664
    DOI: 10.22004/ag.econ.273664
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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. Tomáš Bunčák, 2016. "Exchange Rates Forecasting: Can Jump Models Combined with Macroeconomic Fundamentals Help?," Prague Economic Papers, Prague University of Economics and Business, vol. 2016(5), pages 527-546.
    3. Busch, Thomas & Christensen, Bent Jesper & Nielsen, Morten Ørregaard, 2011. "The role of implied volatility in forecasting future realized volatility and jumps in foreign exchange, stock, and bond markets," Journal of Econometrics, Elsevier, vol. 160(1), pages 48-57, January.
    4. Tomáš Bunčák, . "Exchange Rates Forecasting: Can Jump Models Combined with Macroeconomic Fundamentals Help?," Prague Economic Papers, University of Economics, Prague, vol. 0, pages 1-20.
    5. Bent Jesper Christensen & Morten Ø. Nielsen & Thomas Busch, 2006. "The Information Content Of Treasury Bond Options Concerning Future Volatility And Price Jumps," Working Paper 1188, Economics Department, Queen's University.
    6. Bunčák, Tomáš, 2013. "Jump Processes in Exchange Rates Modeling," MPRA Paper 49882, University Library of Munich, Germany.

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    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G1 - Financial Economics - - General Financial Markets

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