Volkmar Baur of Commerzbank notes that the EUR/USD realized three-month volatility has decreased to around five-year lows. Although he acknowledges that this cannot completely account for the shift, he attributes some of the calm to strongly connected central bank rate expectations, which are somewhat influenced by oil prices. Crucially, implied volatility is currently more than one percentage point higher than historical volatility, indicating that markets anticipate an increase in EUR/USD volatility.
Higher implied volatility and low realized volatility
Despite all of this, yesterday's realized volatility of the EUR/USD exchange rate over the previous three months dropped to 4.53%, which is almost at its lowest point in over five years. Not only that. Only three times in the last nearly two decades (Bloomberg data dates back to May 31, 2007) has the EUR/USD realized 3-month volatility been even lower than it is now. Only 2.2% of trading days have seen it drop below yesterday's level.
"And a comparison with other G10 currencies also demonstrates that, generally speaking, exchange rate volatility against the euro has happened in those currencies where central bank expectations this year exhibit a larger correlation than last year."
Thus, it seems that another element is keeping this year's volatility low. Although the market's attention to oil prices appears to be important, it is insufficient to account for the current extremely low volatility.
One element, though, still sticks out: often, past three-month volatility and anticipated volatility for the upcoming three months (as suggested by option prices) move in close proximity to one another. Eighty percent of the changes in indicated volatility over the last twenty years can be attributed to past volatility. However, there is currently a noticeable disparity. Implied volatility is higher than historical volatility by more than one percentage point.
The difference between the two volatility indicators has only been larger on roughly 4% of trade days over the previous nearly 20 years, given the low overall level. Therefore, the market anticipates that volatility will shortly increase even if it has been low historically during the last three months."
Higher implied volatility and low realized volatility
Despite all of this, yesterday's realized volatility of the EUR/USD exchange rate over the previous three months dropped to 4.53%, which is almost at its lowest point in over five years. Not only that. Only three times in the last nearly two decades (Bloomberg data dates back to May 31, 2007) has the EUR/USD realized 3-month volatility been even lower than it is now. Only 2.2% of trading days have seen it drop below yesterday's level.
"And a comparison with other G10 currencies also demonstrates that, generally speaking, exchange rate volatility against the euro has happened in those currencies where central bank expectations this year exhibit a larger correlation than last year."
Thus, it seems that another element is keeping this year's volatility low. Although the market's attention to oil prices appears to be important, it is insufficient to account for the current extremely low volatility.
One element, though, still sticks out: often, past three-month volatility and anticipated volatility for the upcoming three months (as suggested by option prices) move in close proximity to one another. Eighty percent of the changes in indicated volatility over the last twenty years can be attributed to past volatility. However, there is currently a noticeable disparity. Implied volatility is higher than historical volatility by more than one percentage point.
The difference between the two volatility indicators has only been larger on roughly 4% of trade days over the previous nearly 20 years, given the low overall level. Therefore, the market anticipates that volatility will shortly increase even if it has been low historically during the last three months."
