Is Foreign Exchange Volatility Risk Priced?
FRB of St. Louis Working Paper No. 2004-029C
42 Pages Posted: 27 May 2006
Date Written: May 2006
If there is no priced risk - including volatility risk - associated with hedging an option, then expected delta hedging errors should be zero. This paper finds that delta hedging errors from writing options on foreign exchange futures are significantly positive and unexplained by standard asset pricing models. The volatility of the JPY/USD exchange rate predicts stock returns and is priced in the cross-section of stock returns. Foreign exchange volatility risk might be priced because of its relation to foreign exchange level risk.
Keywords: exchange rate, option, implied volatility, realized volatility, asset pricing
JEL Classification: F31, G15
Suggested Citation: Suggested Citation