Explanatory Factors and Causality in the Dynamics of Volatility Surfaces Implied from OTC Asian-Pacific Currency Options

Computational Economics, Vol. 41, No. 3, pp. 327-358, 2013

51 Pages Posted: 12 May 2012 Last revised: 20 Feb 2013

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: February 1, 2012

Abstract

Volatility implied from observed option contracts systematically varies with the contracts' strike price and time to expiration, giving rise to an instantaneously non-flat implied volatility surface (IVS) that exhibits substantial time variation. We identify a number of latent factors that drive the dynamics of the IVSs from options on 11 Asian-Pacific exchange rates and show that these have a natural interpretation in the law of motion of each surface. We present evidence that these latent factors are related due to their common dependence on exogenous economy-wide variables. Findings suggest that the factors capturing the volatility level of the Japanese yen and the Chinese yuan, the volatility term structure of the Japanese yen, Taiwanese and Australian dollars and the risk aversion towards the Australian dollar, Japanese yen and Chinese yuan seem to incorporate first the investors' expectations regarding the volatility in the region.

Keywords: implied volatility surfaces, currency options, causality, seasonality

JEL Classification: C53, G13, F37

Suggested Citation

Chalamandaris, George and Tsekrekos, Andrianos E., Explanatory Factors and Causality in the Dynamics of Volatility Surfaces Implied from OTC Asian-Pacific Currency Options (February 1, 2012). Computational Economics, Vol. 41, No. 3, pp. 327-358, 2013, Available at SSRN: https://ssrn.com/abstract=2056318

George Chalamandaris

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

76 Patission Street
GR-104 34 Athens
Greece

Andrianos E. Tsekrekos (Contact Author)

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

76 Patission Street
GR-104 34 Athens
Greece

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