Cross-Dynamics of Volatility Term Structures Implied by Foreign Exchange Options

48 Pages Posted: 19 Oct 2005

See all articles by Elizaveta Krylova

Elizaveta Krylova

European Central Bank (ECB)

Jussi Nikkinen

University of Vaasa - Department of Accounting and Finance

Sami Vähämaa

University of Vaasa

Date Written: September 2005

Abstract

This paper examines the cross-dynamics of volatility term structures implied by foreign exchange options. The data used in the empirical analysis consist of daily observations of implied volatilities for OTC options on the euro, Japanese yen, British pound, Swiss franc, and Canadian dollar, quoted against the U.S. dollar. The empirical findings demonstrate that two common factors can explain a vast proportion of the variation in volatility term structures across currencies. Furthermore, the results indicate that the euro is the dominant currency, as the implied volatility term structure of the euro is found to affect all the other volatility term structures, while the term structure of the euro appears to be virtually unaffected by the other currencies. Finally, our results reveal a rather deviant relation between the volatility term structures of the euro and Swiss franc by providing evidence of significant nonlinearities in the relationship between these two currencies.

Keywords: implied volatility, volatility term structure, foreign exchange options

JEL Classification: F31, G13, G15

Suggested Citation

Krylova, Elizaveta and Nikkinen, Jussi and Vähämaa, Sami, Cross-Dynamics of Volatility Term Structures Implied by Foreign Exchange Options (September 2005). ECB Working Paper No. 530. Available at SSRN: https://ssrn.com/abstract=804944

Elizaveta Krylova (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Jussi Nikkinen

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

P.O. Box 700
FIN-65101 Vaasa, FI-65101
Finland
+358 6 3248541 (Phone)

Sami Vähämaa

University of Vaasa ( email )

P.O. Box 700
Vaasa, FI-65101
Finland
+358 29 449 8455 (Phone)

HOME PAGE: http://www.uva.fi/~sami

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