Is implied volatility sensitive to the choice of currency options maturity period?

Hoque, Ariful (2010) Is implied volatility sensitive to the choice of currency options maturity period? Academy of Taiwan Business Management Review, 6 (3). pp. 102-109. ISSN 1813-0534

Official URL: http://www.jtiba.com/

Abstract

Implied volatility (IV) is widely used in pricing options because traders believe that IV is the best predictor of exchange rate volatility. The Philadelphia Stock Exchange offers a continuous series of strike price options that can expire on more than one maturity date. This leads to the question of whether IV is also sensitive to the choice of the options maturity period. To examine this question, this study first chooses two types of options based on the maturity period: (1) within-month-maturity options with expiration period ranges from one day to one month; and (2) next-month-maturity options with an expiration period varying from one month to two months. The IV for within-month-maturity options (WMIV) and next-month-maturity options (NMIV) are estimated. Second, the realized volatility (RV) over the remaining life of the options is constructed from the daily return of exchange rate volatility. The RV for the within-month-maturity options expiration period (WMRV) and the next-month-maturity options expiration period (NMRV) is computed. Finally, graphical and statistical approaches are employed to assess the ability of WMIV and NMIV to explain WMRV and NMRV, respectively. The test results argue that the options with two maturities provide the IV with different characteristics. The analysis also shows that NMIV is superior to WMIV for explaining exchange rate volatility. Therefore, we assert that IV is sensitive to the choice of options maturity period. This novel approach can be used to select the options maturity period for the best IV estimation outcome.


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Item Type: Article (Commonwealth Reporting Category C)
Refereed: Yes
Item Status: Live Archive
Additional Information: Copyright Taiwan Institute of Business Administration.
Depositing User: Dr Ariful Hoque
Faculty / Department / School: Historic - Faculty of Business - School of Accounting, Economics and Finance
Date Deposited: 12 Jan 2011 12:51
Last Modified: 03 Jul 2013 00:03
Uncontrolled Keywords: currency options; implied volatility; realized volatility; MATLAB; within-month-maturity options; next-month-maturity options
Fields of Research (FOR2008): 15 Commerce, Management, Tourism and Services > 1502 Banking, Finance and Investment > 150201 Finance
15 Commerce, Management, Tourism and Services > 1502 Banking, Finance and Investment > 150205 Investment and Risk Management
14 Economics > 1402 Applied Economics > 140210 International Economics and International Finance
Socio-Economic Objective (SEO2008): B Economic Development > 90 Commercial Services and Tourism > 9001 Financial Services > 900199 Financial Services not elsewhere classified
URI: http://eprints.usq.edu.au/id/eprint/8761

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