Option-Implied Volatility Spillovers between Risk Factors in FX Markets and States of the Global Economy

17 Pages Posted: 2 Feb 2016

See all articles by Klaus Grobys

Klaus Grobys

University of Vaasa; University of Jyväskyla

Jari-Pekka Heinonen

University of Vaasa - Department of Accounting and Finance

Date Written: February 1, 2016

Abstract

This study employs option price data to back out the implied portfolio volatilities of the dollar and carry trade risk factors of the G-10 currencies. To investigate expected volatility spillover effects between risk factors in FX markets, we extend Grobys (2015) and Diebold and Yilmaz (2009) by constructing expected volatility spillover indices based upon the forecast-error variance decomposition of Vector-Autoregression models employing option-implied portfolio volatilities. Surprisingly, the dollar and carry trade risk factors that are orthogonal in the first moment exhibit strong stochastic interrelations in the second expected moment. Our findings indicate that expected high spillover regimes are associated with periods of economic stress.

Keywords: Volatility spillovers, currency markets, G10 currencies, option-implied volatility, risk factors, expected volatility, expected portfolio volatility

JEL Classification: G12, G14

Suggested Citation

Grobys, Klaus and Heinonen, Jari-Pekka, Option-Implied Volatility Spillovers between Risk Factors in FX Markets and States of the Global Economy (February 1, 2016). Available at SSRN: https://ssrn.com/abstract=2725917 or http://dx.doi.org/10.2139/ssrn.2725917

Klaus Grobys (Contact Author)

University of Vaasa ( email )

P.O. Box 700
Wolffintie 34
FIN-65101 Vaasa
Finland

University of Jyväskyla ( email )

Jyväskyla
Finland

Jari-Pekka Heinonen

University of Vaasa - Department of Accounting and Finance ( email )

P.O. Box 700
FIN-65101 Vaasa, FI-65101
Finland

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
86
Abstract Views
827
rank
338,451
PlumX Metrics