Embedded Insights from an OTC FX Options Market: Key Players, Investment Strategies and Their Impact on Bid-Ask Spreads and Implied Volatilities
37 Pages Posted: 7 Oct 2008
Date Written: October 5, 2008
This study proposes a more robust estimation of the implied volatility in the FX market, offers a possible explanation to the observed "smile" in implied volatilities based on a "clientele effect", and tests the predictability of future volatilities in the FX market. We employ detailed data on OTC foreign exchange options trading that enable us to examine the behavior of the key players (financial companies, non-financial firms, households and foreign investors) and the investment strategies (straddles, strangles, reversals, synthetic futures, naked calls, and naked puts) used during relatively turbulent and tranquil periods.
Keywords: bid-ask spreads, implied volatility, currency options, markets micro-structure
JEL Classification: F31, G13, G14
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