Predictability in implied volatility surfaces:evidence from the Euro OTC FX market

Chalamandaris, Georgios and Tsekrekos, Andrianos (2014) Predictability in implied volatility surfaces:evidence from the Euro OTC FX market. European Journal of Finance, 20 (1). pp. 33-58. ISSN 1351-847X

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Abstract

Recent general equilibrium models prescribe predictable dynamics in the volatility surfaces that are implied by observed option prices. In this paper, we investigate the predictability of surfaces, using extensive time series of implied volatilities from over-the-counter options on eight different currencies, quoted against the Euro. We examine implied volatility surfaces in the context of predictability through three different models, two that employ parametric specifications to describe the surface and one that decomposes it into latent statistical factors. All examined models are shown to (a) accurately describe the surfaces in-sample, and (b) produce forecasts that are superior to hard-to-beat benchmarks that ignore information about the shape of the surface, in medium- to long-term horizons. We show that these forecasts can support profitable volatility trading strategies in the absence of transaction costs. Comparing across competing models, our results suggest that parametric models, that allow for a more structured description of the surface, are more successful in terms of forecasts’ accuracy and significance of trading profits.

Item Type:
Journal Article
Journal or Publication Title:
European Journal of Finance
Uncontrolled Keywords:
/dk/atira/pure/subjectarea/asjc/2000/2001
Subjects:
ID Code:
64597
Deposited By:
Deposited On:
20 May 2013 08:32
Refereed?:
Yes
Published?:
Published
Last Modified:
18 Nov 2020 12:10