TY  - JOUR
AU  - Campa,Jose M.
AU  - Chang,P. H. Kevin
TI  - The Forecasting Ability of Correlations Implied in Foreign Exchange Options
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 5974
PY  - 1997
Y2  - March 1997
UR  - http://www.nber.org/papers/w5974
L1  - http://www.nber.org/papers/w5974.pdf
N1  - Author contact info:
Jose M. Campa
IESE Business School
Camino del Cerro del Aguila, 3
28023 Madrid
SPAIN
Tel: 34-91-357-0809
Fax: 34-91-357-2913
E-Mail: jcampa@iese.edu
AB  - This paper evaluates the forecasting accuracy of correlation derived from implied volatilities in dollar-mark, dollar-yen, and mark-yen options from January 1989 to May 1995.  As a forecast of realized correlation between the dollar-mark and dollar-yen, implied correlation is compared against three alternative forecasts based on time series data: historical correlation, RiskMetrics' exponentially weighted moving average correlation, and correlation estimated using a bivariate GARCH (1,1) model. At the one-month and three-month forecast horizons, we find that implied correlation outperforms, often significantly, these alternative forecasts.  In combinations, implied correlation always incrementally improves the performance of other forecasts, but not the converse; in certain cases historically based forecasts contribute no incremental information to implied forecasts.  The superiority of the implied correlation forecast holds even when forecast errors are weighted by realized variances, reflecting correlation's contribution to the dollar variance of a multicurrency portfolio.
ER  -