The quality of volatility traded on the over-the-counter currency market: A multiple horizons study

✍ Scribed by Vicentiu Covrig; Buen Sin Low

• Publisher: John Wiley and Sons
• Year: 2003
• Tongue: English
• Weight: 144 KB
• Volume: 23
• Category: Article
• ISSN: 0270-7314
• DOI: 10.1002/fut.10066

✦ Synopsis

Abstract

Previous studies of the quality of market‐forecasted volatility have used the volatility that is implied
by exchange‐traded option prices. The use of implied volatility in estimating the market view of future
volatility has suffered from variable measurement errors, such as the non‐synchronization of option and
underlying asset prices, the expiration‐day effect, and the volatility smile effect. This study circumvents
these problems by using the quoted implied volatility from the over‐the‐counter (OTC)
currency option market, in which traders quote prices in terms of volatility. Furthermore, the OTC currency
options have daily quotes for standard maturities, which allows the study to look at the market's ability to
forecast future volatility for different horizons. The study finds that quoted implied volatility subsumes the
information content of historically based forecasts at shorter horizons, and the former is as good as the latter
at longer horizons. These results are consistent with the argument that measurement errors have a substantial
effect on the implied volatility estimator and the quality of the inferences that are based on it. © 2003
Wiley Periodicals, Inc. Jrl Fut Mark 23:261–285, 2003