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Dissecting Volatility Risks in Currency Markets

78 Pages Posted: 5 Nov 2015  

Ingmar Nolte

Lancaster University - Department of Accounting and Finance

Mark P. Taylor

Washington University in St. Louis - John M. Olin Business School; Centre for Economic Policy Research (CEPR)

Qi Xu

Zhejiang University - School of Economics and Academy of Financial Research

Date Written: November 4, 2015

Abstract

We investigate the pricing of volatility risks in currency markets. First, we show that pricing ability of volatility risk is concentrated in some of its components. Diffusive volatility dominates jump volatility in pricing carry trade returns, while jump volatility is important in jointly explaining carry trade and momentum returns. Both short-run and long-run volatility components are priced, and the short-run component is more important in general. Second, we suggest that factors similar to volatility in identifying bad states, i.e. volatility of volatility and cross sectional volatility are also priced and are not fully subsumed by conventional volatility measures.

Keywords: Foreign Exchange, Carry Trade, Momentum, Volatility, Jump-Diffusion,Short-Run Long-Run Volatility

JEL Classification: C58, F31, G12, G15

Suggested Citation

Nolte, Ingmar and Taylor, Mark P. and Xu, Qi, Dissecting Volatility Risks in Currency Markets (November 4, 2015). Available at SSRN: https://ssrn.com/abstract=2686288 or http://dx.doi.org/10.2139/ssrn.2686288

Ingmar Nolte

Lancaster University - Department of Accounting and Finance ( email )

Lancaster, Lancashire LA1 4YX
United Kingdom

Mark Peter Taylor

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1156
St. Louis, MO 63130-4899
United States

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Qi Xu (Contact Author)

Zhejiang University - School of Economics and Academy of Financial Research

Yuquan Campus 38 Zheda Road
Hangzhou, Zhejiang 310027
China

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