Testing the Expectations Hypothesis on the Term Structure of Volatilities in Foreign Exchange Options

JOURNAL OF FINANCE, Vol 50 No 2, June 1995

Posted: 17 Apr 1995

See all articles by José Manuel Campa

José Manuel Campa

University of Navarra - Madrid Campus - IESE Business School; National Bureau of Economic Research (NBER)

P. H. Kevin Chang

Credit Suisse AG - London Headquarters

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Abstract

This paper tests the expectations hypothesis in the term structure of volatilities in foreign exchange options. In particular, it addresses whether long-dated volatility quotes are consistent with expected future short-dated volatility quotes, assuming rational expectations. For options observed daily from December 1, 1989 to August 31, 1992 on dollar exchange rates against the pound, mark, yen, and Swiss franc, we are unable to reject the expectations hypothesis in the great majority of cases. The current spread between long- and short-dated volatility rates proves to be a significant predictor of the direction of future short-dated rates.

JEL Classification: F31

Suggested Citation

Campa, José Manuel and Chang, P.H. Kevin, Testing the Expectations Hypothesis on the Term Structure of Volatilities in Foreign Exchange Options. JOURNAL OF FINANCE, Vol 50 No 2, June 1995. Available at SSRN: https://ssrn.com/abstract=6118

José Manuel Campa (Contact Author)

University of Navarra - Madrid Campus - IESE Business School ( email )

Camino del Cerro del Aguila 3
Madrid, 28023
Spain
+34 91 357 0809 (Phone)
+34 91 357 2913 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

P.H. Kevin Chang

Credit Suisse AG - London Headquarters ( email )

One Cabot Square
London E14 4QJ
United Kingdom
+44 171 888 8535 (Phone)
+44 171 888 4775 (Fax)

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