FX Volatility Tracker: 3M USD/JPY Implieds Overvalued?

Market Implications

• Three-month implieds are expensive relative to realised for USD/JPY and GBP/USD while they are fairly valued relative to realised for EUR/USD and AUD/USD.
• We find the volatility curve for GBP/USD suggests buying 6M implieds and selling 1Y implieds. Meanwhile, that of USD/JPY suggests buying 1M implieds and selling 3M implieds.

Implied vs Realised Volatility – What’s Cheap/Expensive?

We use a range of realised volatility measures and look at realised with and without major events (FOMC, ECB, BoJ, US CPI and NFP days). Our latest update finds the following:

• EUR/USD: 3M implieds sit within the range of all measures of realised vol with and without key events (Tables 1 and 2, Charts 1 and 2).
• USD/JPY: 3M implieds are expensive to realised vol including key events but fairly valued when excluding key events (Tables 3 and 4, Charts 1 and 3).
• GBP/USD: 3M implieds are expensive to realised vol (Chart 1 and Table 5).
• AUD/USD: 3M implieds are fairly valued to realised vol (Chart 1 and Table 7).

Implied Volatility Slope

We analyse the slope of the ATM implied vol curve across tenors ranging from 1-week to 1-year to establish its steepness/flatness.

We also consider Z-scores of the slope values over the past year to establish how extreme the latest values are. We show the ATM volatility slope on a heatmap where the values correspond to the latest slope value, and the shading corresponds to the z-score of that slope value over the past year.

Our latest data finds the following:

• EUR/USD: all slopes are within one standard deviation of their mean value over the past year (Charts 4 and 6).
  
• USD/JPY: The 3M/1M slope (3M minus 1M) is over one standard deviation above its mean value over the past year (Charts 5 and 7). This suggests buying 1M USD/JPY implieds and selling 3M implieds.
  
• GBP/USD: The 1Y/6M slope (1Y minus 6M) is over one standard deviation above its mean value over the past year (Charts 8 and 10). This suggests buying 6M GBP/USD implieds and selling 1Y implieds.
  
• AUD/USD: all slopes are within one standard deviation of their mean value over the past year (Charts 9 and 11).

Different Measures of Volatility

Tables 1-8 show the realised volatility (with and without big events) for each currency we track using each of the different estimators along with the corresponding implied volatilities.

Volatility Risk Premium

Tables 9-12 show the volatility risk premium (implied volatility minus realised volatility) for each currency across each of the different estimators.

Volatility Risk Premium Percentiles

Tables 13-16 show the 5-year percentiles of the volatility risk premium across each currency, estimator, and period (1 month to 1 year).

Appendix

We recently published a note comparing different measures of realised volatility. This includes the most common measure of realised volatility – close-to-close volatility (also referred to as historical volatility), which is just the standard deviation of (logarithmic) returns over a historical period.

We also consider range-based volatility estimators that make use of intraday price data (e.g., open, high, low, and close) to derive an estimator of realised volatility that may be more precise and efficient than the standard close-to-close measure.

Notably, we implemented five different measures of realised volatility – Table 13 provides a summary of each.

In this report, we update the estimators with the latest data and look at the volatility risk premium across several currencies we track.

Dalvir Mandara is a Quantitative Researcher at Macro Hive. Dalvir has a BSc Mathematics and Computer Science and an MSc Mathematical Finance both from the University of Birmingham. His areas of interest are in the applications of machine learning, deep learning and alternative data for predictive modelling of financial markets.

Photo Credit: depositphotos.com

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)