Index Construction

How an FX volatility index can be built, and why methodology choices matter.

Approach A: Options-Implied Index

An implied-volatility index typically aggregates implied vol quotes (or option prices) across one or more currency pairs and maturities.

Typical inputs

• ATM (at-the-money) implied vol for a chosen tenor (commonly 1M)
• A set of major pairs (e.g., EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CHF, USD/CAD)
• Weights (equal weight, liquidity weight, or trade-weighted approaches)

Design choices that change the index

• Pairs included: G10 vs. EM pairs change sensitivity to global risk
• Tenor: short tenors react faster; longer tenors are smoother
• Aggregation: averaging vols vs. aggregating option prices
• Data quality: quote timing, venue differences, and illiquidity

Approach B: Realized-Vol Index

A realized-volatility index computes volatility from spot returns and then aggregates across pairs.

• Choose a return frequency (daily, intraday)
• Choose a window (e.g., 20–60 trading days)
• Compute volatility per pair and aggregate via weights