Forecasting foreign exchange volatility: why is implied volatility biased and inefficient? and does it matter?

Christopher Neely

No 2002-017, Working Papers from Federal Reserve Bank of St. Louis

Abstract: Research has consistently found that implied volatility is a conditionally biased predictor of realized volatility across asset markets. This paper evaluates explanations for this bias in the market for options on foreign exchange futures. No solution considered?including a model of priced volatility risk?explains the conditional bias found in implied volatility. Further, while implied volatility fails to subsume econometric forecasts in encompassing regressions, these forecasts do not significantly improve delta-hedging performance. Thus this paper deepens the implied volatility puzzle by rejecting popular explanations for forecast bias while demonstrating that statistical measures of bias and informational inefficiency should be treated with circumspection.

Keywords: Forecasting; Foreign exchange rates (search for similar items in EconPapers)
Date: 2004
New Economics Papers: this item is included in nep-cba, nep-ecm, nep-ets, nep-fin, nep-fmk, nep-ifn and nep-rmg
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Citations: View citations in EconPapers (6)

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Journal Article: Forecasting foreign exchange volatility: Why is implied volatility biased and inefficient? And does it matter? (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedlwp:2002-017

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DOI: 10.20955/wp.2002.017

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