Analysing currency options market downturn during global financial crisis (2007-2010)

Mohammad Zakirul Huda

The 24 hours of foreign exchange (FX) market was extremely volatile during the global financial crisis (GFC) due to increased uncertainty about global financial assets' market value and the impact of financial stress on economic performance. The derivative markets had also been partially blamed for the GFC. Further, the Bank for International Settlement (BIS) survey reported a significant downturn in the currency options average daily turnover in the GFC period. Therefore, the objective of this thesis is to analyse the currency options market downturn during GFC. We employed Australian dollar (AUD), Canadian dollar (CAD), Swiss franc (CHF), Euro (EUR) and British pound (GBP) options with one-month, two-month and three-month maturity to analyse three currency options market situations. First, the currency options market efficiency was examined and discussed the influence of currency options mispricing in dropping the average daily currency options turnover. Second, the currency options implied volatility smirk was estimated due to mispricing of out-of-the-money (OTM) put options. Third, underlying currencies of options were assessed as a safe-haven currency. We found AUD, CAD, CHF, and GBP options were mispriced, costly for trading and therefore, traders were reluctant to use these currency options during GFC. Further, the highly volatile AUD, CAD, CHF, and GBP market increased the demand for OTM put options to the risk-averse FX investors that let options be mispriced. Interestingly, the downturn in the currency options market growth during GFC is the combined effects of the currency options market efficiency; the currency options market implied volatility smirk and currency safe-haven attributes. It implies that traders should consider currency options market efficiency, smirk, and safe-haven issues to trade currency options effectively without undesirable costs. Our results also revealed the EUR combination of several currencies worked as a portfolio that protected its value against the US dollar during GFC.

Analysing currency options market downturn during global financial crisis (2007-2010)

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