Nonlinear Features of Realized FX Volatility

John Maheu and Thomas McCurdy

The Review of Economics and Statistics, 2002, vol. 84, issue 4, 668-681

Abstract: This paper investigates nonlinear features of FX volatility dynamics using estimates of daily volatility based on the sum of intraday squared returns. Measurement errors associated with using realized volatility to estimate ex post latent volatility imply that standard time series models of the conditional variance become variants of an ARMAX model. We explore nonlinear departures from these linear specifications using a doubly stochastic process under duration-dependent mixing. This process can capture large abrupt changes in the level of volatility, time-varying persistence, and time-varying variance of volatility. The results have implications for forecast precision, hedging, and pricing of derivatives. © 2002 President and Fellows of Harvard College and the Massachusetts Institute of Technology.

Date: 2002
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