Predictability of Implied Volatility: Evidence from the Over-the-counter Currency Option Markets

Abstract

This paper provides an empirical study on the predictability of implied volatility using dataset collected from the London over-the-counter currency option market. The present work is motivated by the lack of empirical studies that address implied volatility characteristics across various maturities. We applied both in and out-of-sample tests that include the nonparametric variance ratio and interval forecasts methodologies. Contrary to the weak-form market efficiency theory, this study provides evidence of non-random movement in the implied volatility series and indicates predictability of implied volatility series. The result suggests that there is a need to account for the differences in data characteristics that exist across the volatility term structure.