Della Corte, Pasquale, Sarno, Lucio and Tsiakas, Ilias. (2011) Spot and forward volatility in foreign exchange. Journal of Financial Economics, Volume 100 (Number 3). pp. 496-513. ISSN 0304-405X

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Abstract

This paper investigates the empirical relation between spot and forward implied volatility in foreign exchange. We formulate and test the forward volatility unbiasedness hypothesis, which may be viewed as the volatility analogue to the extensively researched hypothesis of unbiasedness in forward exchange rates. Using a new dataset of spot implied volatility quoted on over-the-counter currency options, we compute the forward implied volatility that corresponds to the delivery price of a forward contract on future spot implied volatility. This contract is known as a forward volatility agreement. We find strong evidence that forward implied volatility is a systematically biased predictor that overestimates movements in future spot implied volatility. This bias in forward volatility generates high economic value to an investor exploiting predictability in the returns to volatility speculation and indicates the presence of predictable volatility term premiums in foreign exchange. (C) 2011 Elsevier B.V. All rights reserved.

Item Type:	Journal Article
Subjects:	H Social Sciences > HF Commerce H Social Sciences > HG Finance
Divisions:	Faculty of Social Sciences > Warwick Business School > Finance Group Faculty of Social Sciences > Warwick Business School
Library of Congress Subject Headings (LCSH):	Foreign exchange, Options (Finance) -- Econometric models, Speculation
Journal or Publication Title:	Journal of Financial Economics
Publisher:	Elsevier Science BV
ISSN:	0304-405X
Date:	2011
Volume:	Volume 100
Number:	Number 3
Number of Pages:	18
Page Range:	pp. 496-513
Identification Number:	10.1016/j.jfineco.2011.01.007
Status:	Peer Reviewed
Publication Status:	Published
Access rights to Published version:	Restricted or Subscription Access
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URI:	http://wrap.warwick.ac.uk/id/eprint/41402

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