Spot and Forward Volatility in Foreign Exchange

Speaker:

Ilias Tsiakas
Finance Group
Warwick Business School
The University of Warwick

Coordinator:

Erik Kole
Department of Econometrics
Erasmus School of Economics (ESE)
Erasmus University Rotterdam

Type:

ERIM Research Seminar

Subprogramme:

Finance

Location:

H10-31

Date / Time:

November 12, 2009 (Thursday) / 15:30-16:45 hours

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 is the volatility analogue to the extensively researched hypothesis of unbiasedness in forward exchange rates. Using a new data set of spot implied volatility quoted on over-the-counter currency options, we compute the forward implied volatility that corresponds to the forward contract on future spot implied volatility known as a forward volatility agreement. We find statistically significant evidence that forward implied volatility is a systematically biased predictor that overestimates future spot implied volatility. The 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.

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Contact information:

Erik Kole