Does Option-Implied Cross-Sectional Return Dispersion Forecast Realized Cross-Sectional Return Dispersion? Evidence from the G10 Currencies

Abstract

This study employs option-price data to back out the implied cross-sectional return variance in the G10 currencies. It investigates the relation of implied cross-sectional return dispersion in the currency market and subsequent realized cross-sectional return dispersion. We find that implied cross-sectional return variance, based on option-price data with one-month and three-month maturity, outperforms past cross-sectional return variance in forecasting future cross-sectional return variance.

Keywords: Return dispersion, currency markets, G10 currencies, implied cross-sectional return dispersion

JEL Classification: G21, G14