Foreign exchange, fractional cointegration and the implied-realized volatility relation

Kellard, Neil, Dunis, Christian L. and Sarantis, Nicholas (2007) Foreign exchange, fractional cointegration and the implied-realized volatility relation. Centre for International Capital Markets discussion papers, 2007 (01). pp. 1-32. ISSN 1749-3412

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Abstract / Description

Almost all relevant literature has characterized implied volatility as a biased predictor of realized volatility. This paper provides new time series techniques to assess the validity of this finding within a foreign exchange market context. We begin with the empirical observation that the fractional order of volatility is often found to have confidence intervals that span the stationary/non-stationary boundary. However, no existing fractional cointegration test has been shown to be robust to both regions. Therefore, a new test for fractional cointegration is developed and shown to be robust to the relevant orders of integration. Secondly, employing a dataset that includes the relatively new Euro markets, it is shown that implied and realized volatility are fractionally cointegrated with a slope coefficient of unity. Moreover, the non-standard asymptotic distribution of estimators when using fractionally integrated data is overcome by employing a bootstrap procedure in the frequency domain. Strikingly, tests then show that implied volatility is an unbiased predictor of realized volatility!

Item Type:	Article
Uncontrolled Keywords:	Centre for International Capital Markets discussion papers; CICM discussion papers; market efficiency; traded volatility; narrow band least squares; fractional cointegration; bootstrap
Subjects:	300 Social sciences > 330 Economics
Department:	Guildhall School of Business and Law
Depositing User:	Mary Burslem
Date Deposited:	23 Apr 2015 08:48
Last Modified:	08 May 2018 14:22
URI:	https://repository.londonmet.ac.uk/id/eprint/487

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