How to Calculate Forward Volatility

Calculating forward volatility involves manipulating forward price data.

Forward volatility refers to a measure of how much forward prices for a particular item, such as the Canadian dollar to the U.S. dollar exchange rate, vary from its average value. To calculate forward volatility, it is first necessary to get forward price data. Then the average and standard deviation can be calculated to determine volatility.

Things You'll Need

• Source for price information
• Calculator

Instructions

1. Get forward price data, such as that for the Canadian dollar to the U.S. dollar exchange rate, from a newspaper or the Internet.

2. Write down the prices in a column on a piece of paper. For example, the data might look like this:

   1.02

   1.03

   1.04

   1.05

   1.06

   1.07

   1.08

   1.09

   1.10

   1.11

   1.12

   1.13

3. Calculate the average of this column of numbers by adding them up and dividing by 12. The average is 1.08.

4. Write 1.08 down next to each number.

5. In a third column, subtract the average 1.08 from each number in the first column. For example, the first number in this third column will be 1.02-1.08 = (0.06). The last number will be 1.13-1.08 = 0.05.

6. Use a calculator to square each number in the third column, and write the answers down in a fifth column. It should look like this:

   0.0030

   0.0020

   0.0012

   0.0006

   0.0002

   0.0000

   0.0000

   0.0002

   0.0006

   0.0012

   0.0020

   0.0030

7. Calculate the average of the column of numbers in Step 6 by adding them up and dividing by 12. The answer is 0.0012.

8. Use a calculator to take the square root of this number. The answer is 0.03, which means the forward volatility of the set of exchange rates is 3 percent.

References

• FX Street: Forward Rates