The predictive power of the implied volatility of interest rates: Evidence from US Dollar, Euro, and Japanese Yen

Author: Takahiro Hattori
Date: 2016/7/11
No: DP2016-018
JEL Classification codes: G13, G14, G120, G130
Language: Japanese,English
[ Abstract / Highlights ]

This is the first paper to analyze the predictability of implied volatility based on swaption for the major currencies US Dollar (USD), Euro (EUR), and Japanese Yen (JPY). Managing interest rate risk is of huge importance for risk management in financial institutions, and swaption is an over-the-counter contract and well-used instrument that enables us to test whether the option contains the information required to predict future realized volatility. Our result shows that implied volatility has greater power to predict future realized volatility compared with the GARCH prediction or HV for the USD and EUR, which is consistent with the equity or futures options markets. However, the GARCH forecast and HV have stronger predictive power for JPY because of the lack of liquidity.