I recently have read 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 of 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. In the following example I have applied this to the GBPUSD implied volatility as I thought this would be interesting to look at in the light of the forthcomint BREXIT negocaitions….
Anyhow to do this, I regress the 1, 3, 6 and 12-month GBPUSD implied volatilies against their time values for the period 1996 to Mayr 2017 (i.e 5513 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.
Below are the