TY - JOUR

T1 - Common factors and causality in the dynamics of implied volatility surfaces

T2 - evidence from the FX OTC market

AU - Chalamandaris, G.

AU - Tsekrekos, Andrianos

PY - 2009/6

Y1 - 2009/6

N2 - In this paper we explore the dynamics of Implied Volatility Surfaces (IVS) both in a single-currency framework, and in the context of a global, integrated market. We construct a parametric function of “moneyness” and “time-to-maturity” factors that correspond to common shapes of IVS with evident financial intuition. In the first part of the paper, we analyze the time series properties of the estimated factor loadings coefficients, and at the same time the intuition behind the derived associations between them. The second part of the paper, explores the interaction between IVSs of different currency pairs in two stages. In the first stage, shape transmission between IVSs is examined, using simple linear causality tests. We answer the question whether certain shapes in one currency are transmitted to another. The second stage, involves an exploratory factor analysis to uncover latent common factors, across all currencies, which explain part of IVS variability. Our results uncover large idiosyncratic components in the emerging markets IVSs and dominant common factors that explain most of the variability in the main European currencies.

AB - In this paper we explore the dynamics of Implied Volatility Surfaces (IVS) both in a single-currency framework, and in the context of a global, integrated market. We construct a parametric function of “moneyness” and “time-to-maturity” factors that correspond to common shapes of IVS with evident financial intuition. In the first part of the paper, we analyze the time series properties of the estimated factor loadings coefficients, and at the same time the intuition behind the derived associations between them. The second part of the paper, explores the interaction between IVSs of different currency pairs in two stages. In the first stage, shape transmission between IVSs is examined, using simple linear causality tests. We answer the question whether certain shapes in one currency are transmitted to another. The second stage, involves an exploratory factor analysis to uncover latent common factors, across all currencies, which explain part of IVS variability. Our results uncover large idiosyncratic components in the emerging markets IVSs and dominant common factors that explain most of the variability in the main European currencies.

KW - implied volatility surfaces

KW - currency options

KW - factor model

KW - causality

M3 - Journal article

VL - 6

SP - 49

EP - 74

JO - Journal of Economic Asymmetries

JF - Journal of Economic Asymmetries

SN - 1703-4949

IS - 1

ER -