Brexit and foreign exchange market expectations: Could it have been predicted?

Nikola Gradojevic

Annals of Operations Research, 2021, vol. 297, issue 1, No 8, 167-189

Abstract: Abstract In order to gauge foreign exchange market expectations prior to and after the Brexit vote in June, 2016, this paper examines European options written on the GBP/USD and GBP/EUR exchange rates in 2016. First, the parameter estimates from a non-parametric option pricing model with a homogeneity hint show that the Brexit announcement was to a certain extent expected because the implicit probability density functions were negatively skewed in January–February, 2016 and April–June, 2016. This effect was more pronounced for the GBP/USD exchange rates, indicating an increased pessimism of the U.S. currency traders relative to their European counterparts. Entropic risk measures based on skewness premia of deepest out-of-the-money options confirm the findings from implicit distributions. Moreover, these new risk measures are found to statistically significantly predict foreign exchange market volatility at daily to monthly time horizons.

Keywords: Risk management; Exchange rates; Brexit; Neural networks; Entropy (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1007/s10479-020-03582-z

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