Detrending the realized volatility in the global FX market

^aBusiness Development and Research, ICAP Electronic Broking, Parsippany 07054, NJ, USA

Received 19 November 2008;

revised 2 January 2009.

Available online 28 January 2009.

Abstract

There has been growing interest in realized volatility (RV) of financial assets that is calculated using intra-day returns. The choice of optimal time grid for these calculations is not trivial and generally requires analysis of RV dependence on the grid spacing (so-called RV signature). Typical RV signatures have a maximum at the finest time grid spacing available, which is attributed to the microstructure effects. This maximum decays into a plateau at lower frequencies, which implies (almost) stationary return variance. We found that the RV signatures in the modern global FX market may have no plateau or even have a maximum at lower frequencies. Simple averaging methods used to address the microstructure effects in equities have no practical effect on the FX RV signatures. We show that local detrending of the high-frequency FX rate samples yields RV signatures with a pronounced plateau. This implies that FX rates can be described with a Brownian motion having non-stationary trend and stationary variance. We point at a role of algorithmic trading as a possible cause of micro-trends in FX rates.

Keywords: FX market; Realized volatility; Micro-trends; Detrending

PACS classification codes: 89.65.Gh; 05.45.Tp

Article Outline

1. Introduction

2. Market data

3. Preliminary analysis

4. Detrending realized volatility

5. Discussion

Acknowledgements

References

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