Testing the Expectations Hypothesis on the Term Structure of Volatilities in Foreign Exchange Options

Download or read book Testing the Expectations Hypothesis on the Term Structure of Volatilities in Foreign Exchange Options written by José Manuel Campa and published by . This book was released on 1998 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper tests the expectations hypothesis in the term structure of volatilities in foreign exchange options. In particular, it addresses whether long-dated volatility quotes are consistent with expected future short-dated volatility quotes, assuming rational expectations. For options observed daily from December 1, 1989 to August 31, 1992 on dollar exchange rates against the pound, mark, yen, and Swiss franc, we are unable to reject the expectations hypothesis in the great majority of cases. The current spread between long- and short-dated volatility rates proves to be a significant predictor of the direction of future short-dated rates.