Is implied correlation worth calculating? Evidence from foreign exchange options and historical data

Jose Lopez and Christian Walter

No 2000-02, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: Implied volatilities, as derived from option prices, have been shown to be useful in forecasting the subsequently observed volatility of the underlying financial variables. In this paper, we address the question of whether implied correlations, derived from options on the exchange rates in a currency trio, are useful in forecasting the observed correlations. We compare the forecast performance of the implied correlations from two currency trios with markedly different characteristics against correlation forecasts based on historical, time-series data. For the correlations in the USD/DEM/JPY currency trio, we find that implied correlations are useful in forecasting observed correlations, but they do not fully incorporate all the information in the historical data. For the correlations in the USD/DEM/CHF currency trio, implied correlations are much less useful. In general, since the performance of implied correlations varies across currency trios, implied correlations may not be worth calculating in all instances.

Keywords: options; Foreign exchange (search for similar items in EconPapers)
Date: 2000
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Citations: View citations in EconPapers (20)

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Working Paper: Is implied correlation worth calculating? Evidence from foreign exchange options and historical data (1997)
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