Is Foreign Exchange Volatility Risk Priced?

FRB of St. Louis Working Paper No. 2004-029C

42 Pages Posted: 27 May 2006

See all articles by Hui Guo

Hui Guo

University of Cincinnati - Department of Finance - Real Estate

Christopher J. Neely

Federal Reserve Bank of St. Louis - Research Division

Jason Higbee

Federal Reserve Bank of St. Louis - Research Division

Date Written: May 2006

Abstract

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

Guo, Hui and Neely, Christopher J. and Higbee, Jason, Is Foreign Exchange Volatility Risk Priced? (May 2006). FRB of St. Louis Working Paper No. 2004-029C, Available at SSRN: https://ssrn.com/abstract=904684 or http://dx.doi.org/10.2139/ssrn.904684

Hui Guo (Contact Author)

University of Cincinnati - Department of Finance - Real Estate ( email )

College of Business
418 Carl H. Lindner Hall
Cincinnati, OH 45221
United States
513.556.7077 (Phone)
513.556.0979 (Fax)

HOME PAGE: http://homepages.uc.edu/~guohu/

Christopher J. Neely

Federal Reserve Bank of St. Louis - Research Division ( email )

411 Locust St
Saint Louis, MO 63011
United States
314-444-8568 (Phone)
314-444-8731 (Fax)

HOME PAGE: http://www.stls.frb.org/research/econ/cneely/

Jason Higbee

Federal Reserve Bank of St. Louis - Research Division ( email )

411 Locust St
Saint Louis, MO 63011
United States

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