We document evidence that long dated average expected volatility is higher than that predicted by the term structure relationship during the dramatic appreciation of yen/dollar exchange in the early 1990's.
The implied volatility from stock options is usually bigger than the actual historical volatility. Research therefore suggests the possibility to earn a systematic risk premium by selling at-the-money options short-term. Numerous papers show that this premium is quite substantial - selling put options gives average returns ranging from 0.5% to 1.5% per day. However, strong caution is needed in implementing these short volatility strategies (strategies which exploit the volatility premium by selling volatility - usually selling put options or straddles) as the return distribution is very abnormal (put sellers historically could incur losses up to -800%). There is also a strong serial correlation in large negative days (from the put seller's point of view); therefore, substantial margin reserves are needed when implementing these strategies and returns are then much lower. We present a simple option strategy exploiting the option premium, with a backtested period which includes the 1987 crash.
Commentators often assess New Zealand's exchange rate volatility relative to others using the US dollar as the common term. In comparisons of economies' bilateral exchange rates with the US dollar, this paper finds that the New Zealand dollar is the most volatile (figure 7). The United States makes up the largest part of New Zealand's TWI. Around 17% of New Zealand's trade goes to the United States. While this is significant and will be important for individual exporters, the TWI is a better indicator of economy-wide exposure to exchange rate movements. While the US dollar does make up the largest part of New Zealand's TWI, it only counts for 29% of it, explaining why the NZD/USD is more volatile than New Zealand's TWI (see figure 5). Box 2 explains why movements in the currency of denomination in trade may not have a significant impact on exporters in the medium term.