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Do it with a smile: Forecasting volatility with currency options

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  • Reus, Lorenzo
  • Carrasco, José A.
  • Pincheira, Pablo

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.

Suggested Citation

  • 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).
    • Handle: RePEc:eee:finlet:v:34:y:2020:i:c:s1544612319302831
    DOI: 10.1016/j.frl.2019.07.024
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    References listed on IDEAS

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    More about this item

    Keywords

    Volatility forecast; Volatility smile; Latin American markets; Currency options;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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