Common Factors and Causality in the Dynamics of Implied Volatility Surfaces: Evidence from the FX OTC Market

Journal of Economic Asymmetries, Vol. 6, No. 1, 2009

19 Pages Posted: 25 Nov 2011

See all articles by George Chalamandaris

George Chalamandaris

Athens University of Economics and Business - Department of Accounting and Finance

Andrianos E. Tsekrekos

Athens University of Economics and Business - Department of Accounting and Finance

Date Written: March 15, 2009

Abstract

In this paper we explore the dynamics of Implied Volatility Surfaces (IVS) both in a single-currency framework, and in the context of a global, integrated market. We construct a parametric function of “moneyness” and “time-to-maturity” factors that correspond to common shapes of IVS with evident financial intuition. In the first part of the paper, we analyze the time series properties of the estimated factor loadings coefficients, and at the same time the intuition behind the derived associations between them. The second part of the paper, explores the interaction between IVSs of different currency pairs in two stages. In the first stage, shape transmission between IVSs is examined, using simple linear causality tests. We answer the question whether certain shapes in one currency are transmitted to another. The second stage, involves an exploratory factor analysis to uncover latent common factors, across all currencies, which explain part of IVS variability. Our results uncover large idiosyncratic components in the emerging markets IVSs and dominant common factors that explain most of the variability in the main European currencies.

Keywords: Implied volatility surfaces, Currency options, Factor model, Causality

JEL Classification: C22, F31, F37, G13

Suggested Citation

Chalamandaris, George and Tsekrekos, Andrianos E., Common Factors and Causality in the Dynamics of Implied Volatility Surfaces: Evidence from the FX OTC Market (March 15, 2009). Journal of Economic Asymmetries, Vol. 6, No. 1, 2009, Available at SSRN: https://ssrn.com/abstract=1961966

George Chalamandaris (Contact Author)

Athens University of Economics and Business - Department of Accounting and Finance ( email )

76 Patission Street
GR-104 34 Athens
Greece

Andrianos E. Tsekrekos

Athens University of Economics and Business - Department of Accounting and Finance ( email )

76 Patission Street
GR-104 34 Athens
Greece

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