Forecasting exchange rate volatility: GARCH models versus implied volatility forecasts
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This study investigates whether different specifications of univariate GARCH models can usefully forecast volatility in the foreign exchange market. The study compares in-sample forecasts from symmetric and asymmetric GARCH models with the implied volatility derived from currency options for four dollar parities. The data set covers the period 2002 to 2012. We divide the data into two periods one for the period 2002 to 2007 which is characterised by low volatility and the other for the period 2008 to 2012 characterised by high volatility. The results of this paper reveal that the implied volatility forecasts significantly outperform the three GARCH models in both low and high volatility periods. The results strongly suggest that the foreign exchange market efficiently prices in future volatility.
KeywordsExchange Rate Volatility modelling
JEL classificationE44 G12
We are extremely grateful for comments and suggestions from participants at the annual European Economics and Finance Society conference 2013 in Berlin and the comments of the two anonymous referees.
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