The informational content of implied volatility: Application to the USD/JPY exchange rates

Abstract

This paper tests the information content of the Japanese Yen Implied Volatility Index (JYVIX) regarding the future volatility of USD/JPY exchange rates. We find that JYVIX contains significant information about future volatility, and it even has incremental predictive power over the traditional GARCH-Type models. Implicitly, JYVIX as a looking-forward index provides better forecasts on conditional volatility rather than realized volatility. Our analysis further shows that the forecastability of the GARCH-Type model combined with JYVIX is more credible than these individual models. Specifically, the EGARCH model combined with the exogenous variable JYVIX outperforms all prediction models. Our findings provide a better prediction approach to the volatility of USD/JPY exchange rates, which has far-reaching significance for risk management in Asian economies.