Forecasting implied volatility in foreign exchange markets : a functional time series approach

Kearney, Fearghal and Cummins, Mark and Murphy, Finbarr (2018) Forecasting implied volatility in foreign exchange markets : a functional time series approach. European Journal of Finance, 24 (1). pp. 1-18. ISSN 1351-847X (https://doi.org/10.1080/1351847X.2016.1271441)

[thumbnail of Kearney-etal-EJF-2018-Forecasting-implied-volatility-in-foreign-exchange-markets]
Preview
 Text. Filename: Kearney_etal_EJF_2018_Forecasting_implied_volatility_in_foreign_exchange_markets.pdf
Accepted Author Manuscript
Download (843kB)| Preview

Abstract

We utilise novel functional time series (FTS) techniques to characterise and forecast implied volatility in foreign exchange markets. In particular, we examine the daily implied volatility curves of FX options, namely; Euro/United States Dollar, Euro/British Pound, and Euro/Japanese Yen. The FTS model is shown to produce both realistic and plausible implied volatility shapes that closely match empirical data during the volatile 2006–2013 period. Furthermore, the FTS model significantly outperforms implied volatility forecasts produced by traditionally employed parametric models. The evaluation is performed under both in-sample and out-of-sample testing frameworks with our findings shown to be robust across various currencies, moneyness segments, contract maturities, forecasting horizons, and out-of-sample window lengths. The economic significance of the results is highlighted through the implementation of a simple trading strategy.

ORCID iDs

Kearney, Fearghal, Cummins, Mark ORCID logoORCID: https://orcid.org/0000-0002-3539-8843 and Murphy, Finbarr;
  • Item type:Article
    ID code:82436
    Dates:
    Date
    Event
    2 January 2018
    Published
    26 January 2017
    Published Online
    3 December 2016
    Accepted
    Subjects:Social Sciences > Finance
    Department:UNSPECIFIED
    Depositing user: Pure Administrator
    Date deposited:22 Sep 2022 13:17
    Last modified:21 Nov 2024 01:22
    Related URLs:
    URI:https://strathprints.strath.ac.uk/id/eprint/82436
CORE (COnnecting REpositories)