Journal Article

The Accuracy of Density Forecasts from Foreign Exchange Options

Peter Christoffersen and Stefano Mazzotta

in Journal of Financial Econometrics

Volume 3, issue 4, pages 578-605
Published in print January 2005 | ISSN: 1479-8409
Published online August 2005 | e-ISSN: 1479-8417 | DOI: http://dx.doi.org/10.1093/jjfinec/nbi021
The Accuracy of Density Forecasts from Foreign Exchange Options

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Financial decision makers often consider the information in currency option valuations when making assessments about future exchange rates. The purpose of this article is to systematically assess the quality of option-based volatility and density forecasts. We use a unique dataset consisting of more than 10 years of daily data on over-the-counter (OTC) currency option prices. We find that the OTC implied volatilities provide largely unbiased and fairly accurate forecasts of one-month- and three-month-ahead realized volatility. Furthermore, we find that the one-month option implied density forecasts are well calibrated for the center of the distribution, but we find evidence of misspecification in the tail density forecasts.

Keywords: density; forecasting; FX; interval; volatility

Journal Article.  9898 words.  Illustrated.

Subjects: Financial Markets ; Econometrics and Mathematical Economics

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