Volatility Smile and One-Month Foreign Currency Volatility Forecasts

Alfred Huah Syn Wong; Richard A. Heaney

doi:10.1002/fut.21799

Volatility Smile and One-Month Foreign Currency Volatility Forecasts

Alfred Huah Syn Wong, Richard A. Heaney

Research output: Contribution to journal › Article › peer-review

5 Citations (Scopus)

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.

Original language	English
Pages (from-to)	286-312
Number of pages	27
Journal	Journal of Futures Markets
Volume	37
Issue number	3
DOIs	https://doi.org/10.1002/fut.21799 https://doi.org/10.1002/fut.21799
Publication status	Published - 1 Mar 2017

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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.",

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Volatility Smile and One-Month Foreign Currency Volatility Forecasts

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