Hidden Correlations: A Self-Exciting Tale from the FX World

33 Pages Posted: 27 Sep 2018

See all articles by Laura Ballotta

Laura Ballotta

Bayes Business School (formerly Cass) - City, University of London

Alessandro Morico

City University London - The Business School

Date Written: September 8, 2018

Abstract

The aim of this paper is to investigate the dependence between exchange rates and their volatility from the information synthesised into currency options quotes. To this purpose, we propose an affine stochastic volatility model with self-exciting structure under a timechanged pure jump Lévy framework. In particular, we construct a mechanism inducing dependence effects via systematic jumps. The performance analysis shows that this factor construction marginally improves the pricing of FX options in terms of calibration and fit of the implied volatility surface, indicating that this dependence is of moderate nature. Therefore, we have evidence to claim that there exists a mild correlation between exchange rates and their volatility.

Keywords: Volatility Skew, Time-Changed Lévy Processes, Affine

JEL Classification: C51, D52, G12, G13

Suggested Citation

Ballotta, Laura and Morico, Alessandro, Hidden Correlations: A Self-Exciting Tale from the FX World (September 8, 2018). Available at SSRN: https://ssrn.com/abstract=3245149 or http://dx.doi.org/10.2139/ssrn.3245149

Laura Ballotta

Bayes Business School (formerly Cass) - City, University of London ( email )

Faculty of Finance
106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

HOME PAGE: http://www.city.ac.uk/people/academics/laura-ballotta

Alessandro Morico (Contact Author)

City University London - The Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

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