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Volatility, momentum, and time-varying skewness in foreign exchange returns

Subject

Finance

Publishing details

Authors / Editors

Johnson T

Publication Year

2001

Abstract

This paper tests a stochastic volatility model of exchange rates which links both the level of volatility and its instantaneous covariance with returns to pathwise properties of the currency. In particular, the model implies that the return-volatility covariance behaves like a weighted average of recent returns, and hence switches signs according to the direction of trends in the data. This implies that the skewness of the finite-horizon return distribution likewise switches sign, leading to time-varying implied volatility "smiles " in options prices. The model is fit and assessed using Bayesian techniques. Some previously reported volatility results are accounted for by the fitted models. The predicted pattern of skewness dynamics accords well with that found in historical options prices.

Publication Research Centre

Institute of Finance and Accounting

Series Number

FIN 324

Series

IFA Working Paper

Available on ECCH

No


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