A volatility smile-based uncertainty index

José Valentim Machado Vicente () and Jaqueline Terra Moura Marins ()
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José Valentim Machado Vicente: Central Bank of Brazil
Jaqueline Terra Moura Marins: Central Bank of Brazil

Annals of Finance, 2021, vol. 17, issue 2, No 4, 246 pages

Abstract: Abstract We propose a new uncertainty index based on the discrepancy of the smile of FX options. We show that our index spikes near turbulent periods, forecasts economic activity and its innovations hold a significant and negative equity premium. Unlike other uncertainty indexes, our index is supported by equilibrium models, which relate the difference of options prices across moneyness to uncertainty. Moreover, our index is based on investment decisions, can be easily and continuously updated and is comparable across countries.

Keywords: Uncertainty; FX option; Volatility smile; Risk (search for similar items in EconPapers)
JEL-codes: D80 F31 G12 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1007/s10436-021-00384-6

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