2001-01

Nonlinear Features of Realized FX Volatility
John M. Maheu, Thomas H. McCurdy
February 2001

Abstract

This paper investigates nonlinear features of FX volatility dynam- ics using estimates of daily volatility based on the sum of intraday squared returns. Measurement errors associated with using realized volatility to measure ex post latent volatility imply that standard time series models of the conditional variance become variants of an AR- MAX model. We explore nonlinear departures from these linear spec- ications using a doubly stochastic process under duration-dependent mixing. This process can capture large abrupt changes in the level of volatility, time-varying persistence, and time-varying variance of volatility. The results have implications for forecast precision, hedg- ing, and pricing of derivatives.

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