Do it with a smile: Forecasting volatility with currency options

Lorenzo Reus, José A. Carrasco, Pablo Pincheira

Research output: Contribution to journalArticlepeer-review

Abstract

We show that traditional measures of curvature and symmetry of the “smiles” improve volatility predictions in forex markets. We consider post crisis data at a daily basis for seven currencies vis a vis the American dollar: The British pound, the Euro, the Australian dollar, the Japanese yen, the Brazilian real and the Mexican and Chilean peso. While our results are robust to the option currency and maturity, they are particularly strong for latin-American currencies and options with longer maturity. We find that the simultaneous inclusion of skewness and kurtosis to a forecasting model significantly improves its predictive accuracy.

Original languageEnglish
Article number101251
JournalFinance Research Letters
Volume34
DOIs
StatePublished - May 2020
Externally publishedYes

Keywords

  • Currency options
  • Latin American markets
  • Volatility forecast
  • Volatility smile

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