Speaker: Lucio Sarno (City University London)
Venue: MNB-Visitor Centre
Time: 15:15 pm, Wednesday, March 17, 2010
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 may be viewed as the volatility analogue to the extensively researched hypothesis of unbiasedness in forward exchange rates. Using new data sets of spot implied volatility quoted on over-the-counter currency options, we compute the forward implied volatility that corresponds to the delivery price of a forward contract on future spot implied volatility. This contract is known as a forward volatility agreement. We find strong evidence that forward implied volatility is a systematically biased predictor that overestimates future spot implied volatility. This 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.
Keywords: Implied Volatility; Foreign Exchange; Forward Volatility Agreement; Unbiasedness; Volatility Speculation.
JEL Classification: F31; F37; G10; G11