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Testing the Expectations Hypothesis on the Term Structure of Volatilities in Foreign Exchange Options
Author(s) -
CAMPA JOSÉ MANUEL,
CHANG P. H. KEVIN
Publication year - 1995
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1995.tb04794.x
Subject(s) - volatility (finance) , economics , liberian dollar , foreign exchange , term (time) , econometrics , pound (networking) , us dollar , implied volatility , financial economics , rational expectations , exchange rate , monetary economics , finance , computer science , physics , quantum mechanics , world wide web
This article 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.