SWARCH and the implicit volatility of the Real/USD exchange rate

Abstract

This paper evaluates empirically the volatility prediction and the informational content of the exchange rate variation. The comparison is built on two different models. The first is a markov switching model on the conditional variance – SWARCH (Hamilton, 1994). The second model is based on the Garman e Kohlhagen (1983) option pricing model, from which one extracts the implicit volatility. The results show that the SWARCH’s performance is better in both dimensions and contrast with the literature in two aspects: first because the model with switching regime is not as usual as the ones without it, second because the best model is based on historical data rather than implicit volatility.