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The Volatility Risk Premium Embedded in Currency Options

Published online by Cambridge University Press:  06 April 2009

Buen Sin Low  and
Shaojun Zhang
Buen Sin Low
Affiliation:
abslow@ntu.edu.sg, Division of Banking and Finance, Nanyang Technological University, Singapore 639798.
Shaojun Zhang
Affiliation:
asjzhang@ntu.edu.sg, Division of Banking and Finance, Nanyang Technological University, Singapore 639798.
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Abstract

This study employs a non-parametric approach to investigate the volatility risk premium in the over-the-counter currency option market. Using a large database of daily delta-neutral straddle quotes in four major currencies—the British pound, the euro, the Japanese yen, and the Swiss franc—we find that volatility risk is priced in all four currencies across different option maturities. We find that the volatility risk premium is negative, with the premium decreasing in maturity. Finally, we also find evidence that jump risk may be priced in the currency option market.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 40 , Issue 4 , December 2005 , pp. 803 - 832
Copyright
Copyright © School of Business Administration, University of Washington 2005

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