Article1994

The Term Structure of Volatility Implied by Foreign Exchange Options

159 citations0/0 files storedJournal of Financial and Quantitative Analysis

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Stochastic processes and financial applications Financial Markets and Investment Strategies Financial Risk and Volatility Modeling

Abstract

This paper illustrates regression and Kalman filtering methods for estimating the time-varying term structure of volatility expectations revealed by options prices. Short- and long-term expectations are estimated for four currencies using daily PHLX options prices from 1985 to 1989. Throughout this period, there were important differences between shortand long-term expectations. The slope of the term structure changed frequently and there were significant variations in long-term volatility expectations. The expectation estimates can be used to value OTC options, to improve hedging strategies, and to test the hypothesis that the options market overreacts.

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References

1992ARCH modeling in finance 1987The Pricing of Options on Assets with Stochastic Volatilities 1991Stock Price Distributions with Stochastic Volatility: An Analytic Approach 1987Efficient Analytic Approximation of American Option Values 1992Stock market volatility and the information content of stock index options 1993Forecasting Stock-Return Variance: Toward an Understanding of Stochastic Implied Volatilities 1989Overreactions in the Options Market 1994Analysis of the Term Structure of Implied Volatilities

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1995Implied Volatility 1995Conditional volatility and the informational efficiency of the PHLX currency options market 2000The Dynamics of the S&P 500 Implied Volatility Surface 2012U.S. stock market crash risk, 1926–2010 1997The Forecasting Ability of Correlations Implied in Foreign Exchange Options 1995Testing the Expectations Hypothesis on the Term Structure of Volatilities in Foreign Exchange Options

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