TY - JOUR
T1 - Forecasting implied volatility in foreign exchange markets
T2 - a functional time series approach
AU - Kearney, Fearghal
AU - Cummins, Mark
AU - Murphy, Finbarr
N1 - Publisher Copyright:
© 2017 Informa UK Limited, trading as Taylor & Francis Group.
PY - 2018/1/2
Y1 - 2018/1/2
N2 - 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.
AB - 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.
KW - Exchange rates
KW - forecasting
KW - functional data analysis
KW - functional time series
KW - implied volatility
UR - http://www.scopus.com/inward/record.url?scp=85010699979&partnerID=8YFLogxK
U2 - 10.1080/1351847X.2016.1271441
DO - 10.1080/1351847X.2016.1271441
M3 - Article
AN - SCOPUS:85010699979
SN - 1351-847X
VL - 24
SP - 1
EP - 18
JO - European Journal of Finance
JF - European Journal of Finance
IS - 1
ER -