Monthly Archives: November 2016

G10 FX Risk Report Update

The following analysis uses a proprietary G10 FX implied volatility index which I created quite a few years ago. The index is a G10 FX 1-month implied volatility index which weights are derived from the BIX FX triennal surveys for the year 2001,2003 & 2007. If you want more information on the exact formulation of the index feel free to contact me for a chat. For the time being suffice to say that the G10 FX volatility index is a broad and accurately weighted measure of G10 FX risk.

In my approach I recognise that the nominal level of implied volatility is a crude metric of risk therefore I also use two other measures, namely Volga and the ShockIndex. The Volga is simply the volatility of the G10 FX volatility index over a given period. This measure highlights how uncertain and unstable the level of risk in G10 FX has become. Though generally positively correlated those measures of risk can diverge from time to time. You can have a high level of volga whilst G10 FX volatilities are trading at rather innocuous levels. This is not a trivial observation as the leverage undertaken by market participants tends to be an inverse function of market volatility which implies a greater vulnerability when volatility becomes uncertain at low levels and therefore cannot be accurately budgeted for. The ShockIndex is the ratio between the Volga and the G10 FX volatility index at the beginning the historical window chosen to evaluate the Volga. It quantifies sharp changes and acceleration in risk levels. Historically it has proven to be a good classifying measure for market event risks in FX markets.

The below charts shows those three measures both relative to a time axis and their historical distribution. The red lines are the 95% confidence intervals, the purple line the median. The blue line highlight the current level. The Volga and ShockIndex in this report are evaluated over a period of 14 days. The medians and 95% confidence intervals are calculated over the full history going back to 1996 though the charts shows only the recent years.

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At close of business the 2016-11-04 the G10 FX volatility index was estimated at 8.6 % at the 69.3 percentile. The 14-day G10 FX Volga was estimated at 5.1 % its 71.7 percentile and the shockindex at 0.7 or its 72.4 percentile.

The above charts are useful, however their visualisation is quite limiting. On the one hand we need quite a few charts to present the data on the other hand it is difficult to show the full G10 FX volatility Index history going back to 1996 as this would make the charts unreadable. Therefore clustering and aggregating the whole data into a single chart should be useful to the end user. To answer this I use a mapping technique developed by Kohonen in the 1980′. It uses an unsupervised neural network to re-arrange data around meaningful clusters. Though computationally complex is a practical way to summarise multidimensional data into a low (usually 2) dimensional system.

The below chart shows how the G10 FX Volatility Index history was split into 4 distinct clusters. Those clusters where computed not only as a function of the G10 FX Volatility Index level but also as a function of the other discussed variables, namely Volga and Shockindex.

Since 1996 the G10 FX volatility Index traded 59 % of the time in Cluster 1, 29 % in Cluster 2, 8 % in Cluster 3 and 3 % in Cluster 4. Overall the layering provided seems quite intuitive as the increase in risk and time spent in each cluster points toward what would generally be expected from market risk regimes ranging from low to high risk.

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In the chart below we zoom on the various regimes within which the G10 FX Volatility Index hasevolved for the current year. so far it remained 69 % of the time in Cluster 1, 21 % in Cluster 2, 10 % in Cluster 3 and 0 % in Cluster 4.

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Finally the below chart shows a Self Organising Map of the above mentioned risk metrics. The data has been grouped and colored as a function of four clusters of increasing market risk regimes. Obviously as shown on the map, the minimum level of volatility pertains to cluster 1 and the highest to cluster4. The current regime and its progression from 21 days ago is also highlighted on the map.

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Minimum Spanning Trees and G10FX implied volatilities…

I have always been keen on clustering methods as they are a practical way to visualise meaningful relationships that may exist in the somehow chaotic financial markets…..Following my previous post on the subject I decided to extend this to FX Implied volatilies…

The following charts show how major 1-month FX volatilities have been trading over the last 20-years and for 2016.

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The folowing charts shows the correlations of daily changes since 1996 and for 2016.

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The below plot the minimum spanning tree for G10FX implied vols. The distance between the nodes being a function of the above correlations. Some groupings are quite intuitive…some other less so…I would say the recent period seems to be at odd with the period 2010-2015 where we had two specific group: one for European currencies the other for commodity currencies….

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If you want a natter about this or just to exchange some ideas on the subject or other concepts presented in my blog, contact me at

G10 FX Implied Volatilities: Cheap or Expensive ?

The following report provides a granular analysis of implied volatilities within G10 FX. I use primarily the same formatting than for my G10FX positioning report to estimate how extended the 1-month FX implied volatilities are over various time horizon.

The first set of charts shows the historical T-stat of the 1-day changes in 1-month implied volatilities over a rolling period of 61-days. This is my statistical metric to quantify how stretched the implied volatilities are, but clearly other time period could be used as shown further down on in that report. The purple line represents the median value since 1996 and the red lines represent the 95% confidence intervals. Therefore if the value is above or below those the deviation of the given implied volatility should be deemed as atypical relative to what would be expected under a normal distribution (I am not saying that implied volatilities have a normal behaviour to be clear….) and therefore overbought/oversold.

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The below charts shows the current implied volatilities relative to their historical distributions since 1996. Once again the red lines delimit the 95% confidence intervals and the purple line the median value. The blue line indicates the most current level of 1-month implied volatility.

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Finally the below shows a stretch map of the T-Stats to help visualise how much implied volatilities have departed from their equilibrium levels over time horizons ranging from 1-month to 6-month. The bigger the square the most significant the observed upside (Green) or downside (Red) of the implied volatility over the given period.

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