I was recently reading a paper titled The yen/dollar exchange rate in 1998: views from options markets written by the Bank of England back in November 1998. This got me to think on how I could best represent in one chart the relationship between the slope of the implied volatility term structure of and the nominal level o the 1-month volatility.
To do this I regressed the 1, 3, 6 and 12-month GBP-USD implied volatilies against their time values for the period 1996 to December 2016 (i.e 5427 volatility curves). I derived the volatility curve slopes t_stats for each day and then classified the 1-month volatilities into three groups as a function of the significance level of the slope t-stats. The chart below shows the 1-month implied volatiliy over the full period. When the volatility curve slope was positvely significant at 95% critical threshold the data is shown in green, When there was a signicantly negative slope at the 95% critical threshold the data is shown in red and pale blue for the remainder. I think this is a neat way highlight that time of high volatility are associated with a volatility curve that slope downwardly and vice-versa.
