Currency Pair Volatility Depends on Both Currencies and Their Correlation

# Why are some currency pairs more volatile than others?


# Why are some currency pairs more volatile than others?












Why for example GBP/JPY is twice volatile as USD/JPY ? ... and many more cases involving other major forex pairs here: full list.

thanks in advance!

## Answer by demully (score 5, accepted)

https://quant.stackexchange.com/a/50877

OK, think of this like you were picking between stocks... but you could only pick one stock to buy by picking a stock to sell.

You pick two miners, BHP and Rio. Both have massive iron ore exposure, so both are very volatile against anything else. Let's call this risk "AUD" for argument's sake ;-) But against each other, they tend to move in tandem, with little relative volatility. Looking between the two, you know that BHP also has energy exposure that Rio does not. So the BHP/Rio ratio tends to correlate with Exxon and Shell. Let's call this phenomenon "AUDNOK" or "AUDCAD" for argument's sake ;-)

The key problem in FX is that you are always dealing with two currencies. Obvious and trivial, but nevertheless important. One can never seperate out, let alone measure, the risk in two currencies XXXYYY, given only XXX and YYY.

But you can, given a third currency ZZZ (and thus XXXZZZ and YYYZZZ). Just like a 3-stock portfolio, the volatility of XXXYYY will become a function of the volatity of XXX, that of YYY, and the correlation between both and ZZZ. This is no different from the portfolio risk of eg buying Apple and Gold ;-)

Add in additional currencies (AAA, BBB etc.) and there will exist (complicated) algos to define the precise risk parameters of any single currency in your sample set. But the complexity of the task scales exponentially with the number of currencies chosen ;-(

So in your case, it's usual just to look at GBPJPY and USDJPY; and thus also GBPUSD. Assuming an independent "pound-ness", "yen-ness" and "dollar-ness", the volatility of each and the inter-correlation with each other can be deduced.

All of which allows an internally consistent FX system that prevents arbitrage. That's a critical but dull^2 observation. Which is important, because anything else fails any basic integrity test.

## Answer by Yugmorf (score 2)

https://quant.stackexchange.com/a/50777

Because of differing underlying factor risks. These might include such things as policy risk (eg. tax, capital controls), central bank intervention risk (eg. a currency peg at one extreme), economic factors (eg. sensitivity to outlook for GDP growth and inflation), and financial market risk dependencies (eg. interest rate differentials, equity market risk).

## Answer by gregV (score 1)

https://quant.stackexchange.com/a/50909

This link posted appears to show historical vol which is never an accurate indication of future volatility assuming the stochastic (random) process. There is also no info at how they calculate what they output.

However, it's highly unlikely that GBPJPY is twice as volatile as USDJPY. To test, i put 2 ATM 3M FX options into Bloomberg calculator and indicated 3M implied vol is ~ 7% for GBPJPY and ~5% for USDJPY.