Implied volatility smirk in the Australian dollar market

2021 ◽  
Author(s):  
Connor J.A. Stuart ◽  
Sebastian A. Gehricke ◽  
Jin E. Zhang ◽  
Xinfeng Ruan
Keyword(s):  
Implied Volatility ◽  
Australian Dollar

scholarly journals An Open Innovation Intraday Implied Volatility for Pricing Australian Dollar Options

2021 ◽  
Vol 7 (1) ◽  
pp. 23
Author(s):  
Thi Le ◽  
Ariful Hoque ◽  
Kamrul Hassan
Keyword(s):  
Implied Volatility ◽  
Mean Squared Error ◽  
Absolute Error ◽  
Currency Options ◽  
Essential Information ◽  
Australian Dollar ◽  
Pricing Options ◽  
Error Measures ◽  
Squared Error ◽  
Foreign Exchange Volatility

This study introduces the intraday implied volatility (IV) for pricing the Australian dollar (AUD) options. The IV is estimated using the at-the-money one-month, two-month, and three-month maturity AUD options traded in the opening, midday, and closing period of a trading day. The Mincer-Zarnowitz regression test evaluates the predictive power of IV to forecast the foreign exchange volatility for the within-week, one-week, and one-month horizon. The mean absolute error, mean squared error, and root mean squared error measures are employed to assess the performance of IV in estimating the price of currency options for the within-week, one-week, and one-month horizon. This study reveals four critical findings. First, a three-month maturity IV does not contain vital information for pricing options. Second, IV incorporated information is not relevant to compute the value of options for a horizon of less than a week. Third, IV in the closing period of Monday or Tuesday subsumes most of the essential information to estimate options price. Fourth, the shorter (longer) maturity IV provides critical information to price options for the shorter (longer) horizon. The intraday IV is a new dimension of unobservable volatility in accurately pricing currency options for researchers and practitioners.

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