The Handbook of News Analytics in Finance

3.6 NEWS INDICES AND FX IMPLIED VOLATILITY

In Section 3.5, we showed that event indices, on average, have an impact on realized FX volatility. Since FX implied volatility indices also forecast realized volatility (see Pong et al., 2004; Taylor, 2005), this suggests that implied volatility and news indices might be related. On the other hand, there is an important difference between the two: while event indices are calibrated to predict volatility over 30-minute periods, implied volatility indices forecast volatility over much longer periods, typically about 30 days. The event study methodology was employed to determine whether a relationship between the two does, in fact, exist. No evidence to that effect was found; this suggests that implied volatility and event indices may function as complementary sources of information for risk management, each focused on a different time horizon.

3.6.1 Data pre-processing

Bank quotes for implied euro volatility were obtained from Thomson Reuters for 2005 to mid-2007. Preliminary exploration revealed that the major banks quote persistent, yet statistically different implied volatilities (it is not uncommon for different banks to quote implied volatilities that differ by 3 standard deviations or more). This means that one could easily mistake changes in quote provider for genuine changes in implied volatility. To preempt such errors, and to focus on the relationship between implied volatility and news, we select one source of quotes for our ...