Forecasting foreign exchange volatility: Why is implied volatility biased and inefficient? And does it matter?

Christopher Neely

Journal of International Financial Markets, Institutions and Money, 2009, vol. 19, issue 1, 188-205

Abstract: Research has consistently found that implied volatility is a conditionally biased predictor of realized volatility across asset markets. This paper evaluates explanations for this bias in the market for options on foreign exchange futures. Several recently proposed solutions - including a model of priced volatility risk - fail to explain a significant portion of the conditional bias found in implied volatility. Further, while implied volatility fails to subsume econometric forecasts in encompassing regressions, these forecasts do not significantly improve delta-hedging performance. Thus this paper argues that statistical metrics are inappropriate measures of the information content of implied volatility. Implied volatility appears much more useful when measured by a more relevant, economic metric.

Keywords: Exchange; rate; Option; Implied; volatility; GARCH; High-frequency (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (15)

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Working Paper: Forecasting foreign exchange volatility: why is implied volatility biased and inefficient? and does it matter? (2004)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:intfin:v:19:y:2009:i:1:p:188-205

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