The Accuracy of Density Forecasts from Foreign Exchange Options

Peter Christoffersen and Stefano Mazzotta

Journal of Financial Econometrics, 2005, vol. 3, issue 4, 578-605

Abstract: Financial decision makers often consider the information in currency option valuations when making assessments about future exchange rates. The purpose of this article is to systematically assess the quality of option-based volatility and density forecasts. We use a unique dataset consisting of more than 10 years of daily data on over-the-counter (OTC) currency option prices. We find that the OTC implied volatilities provide largely unbiased and fairly accurate forecasts of one-month- and three-month-ahead realized volatility. Furthermore, we find that the one-month option implied density forecasts are well calibrated for the center of the distribution, but we find evidence of misspecification in the tail density forecasts. Copyright 2005, Oxford University Press.

Date: 2005
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