Research output: Contribution to Journal/Magazine › Journal article › peer-review
Research output: Contribution to Journal/Magazine › Journal article › peer-review
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TY - JOUR
T1 - Predictable dynamics in implied volatility surfaces from OTC currency options
AU - Chalamandaris, Georgios
AU - Tsekrekos, Andrianos
PY - 2010/6
Y1 - 2010/6
N2 - Recent empirical studies report predictable dynamics in the volatility surfaces that are implied by observed index option prices, such as those prescribed by general equilibrium models. Using an extensive data set from the over-the-counter options market, we document similar predictability in the factors that capture the daily variation of surfaces implied by options on 25 different foreign exchange rates. We proceed to demonstrate that simple vector autoregressive specifications for the factors can help produce accurate out-of-sample forecasts of the systematic component of the surface at short horizons. Profitable delta-hedged positions can be set up based on these forecasts; however, profits disappear when typical transaction costs are taken into account and when trading rules on wide segments of the surface are sought.
AB - Recent empirical studies report predictable dynamics in the volatility surfaces that are implied by observed index option prices, such as those prescribed by general equilibrium models. Using an extensive data set from the over-the-counter options market, we document similar predictability in the factors that capture the daily variation of surfaces implied by options on 25 different foreign exchange rates. We proceed to demonstrate that simple vector autoregressive specifications for the factors can help produce accurate out-of-sample forecasts of the systematic component of the surface at short horizons. Profitable delta-hedged positions can be set up based on these forecasts; however, profits disappear when typical transaction costs are taken into account and when trading rules on wide segments of the surface are sought.
KW - implied volatility surfaces
KW - static factor model
KW - forecasting
U2 - 10.1016/j.jbankfin.2009.11.014
DO - 10.1016/j.jbankfin.2009.11.014
M3 - Journal article
VL - 34
SP - 1175
EP - 1188
JO - Journal of Banking and Finance
JF - Journal of Banking and Finance
SN - 0378-4266
IS - 6
ER -