Hi,I've got a few of questions. Can you tell me which currency pairs have the most pronounced FX smile? Do the major currency pairs have a less or more pronounced FX smile than the emerging currency pairs in general? Also am I right to assume that the implied correlation for FX options will be closer to zero for shorter dated options?Thanks in advance

I thought most thinly traded pairs exhibited skews rather than a full smile.

Correct me if I'm wrong: I imagine that a smile is in part a function of the kurtosis (derived from actual OTM 25d/10d butterfly spreads over ATM). So I guess a "pronounced" smile is a result of wider fly spreads above (or sometimes below) ATM levels. I think a wider butterfly spread-over-ATM (i.e. a pronounced smile?) either implies that the market in general is very volatile and could go either way, or that the currency pair itself is so illiquid that there are not enough market makers.In some thinly-traded currency pairs, there may not even be an active OTM market, so much so that the only vols being published on Reuters or Bloomberg are the ATMs, resulting in a flat surface across all expiries i.e. no smile at all.

The smile offers a view of the behaviour of the underlying volatility - and the correlation between the underlying price movements and volatility. ie. equity markets exhibit a negative skew as volatility tends to increase when markets fall (negative correlation between price and vol.) Similarly, when FX markets drift away from their long term average the volatility increases - and hence the smile is observed. FX skews are generally observed when one currency is "stronger" than the other. ie. USD/THBI would disagree with imranyusof's last comment. Thinly traded options should exhibit a greater skew - as traders will have more difficulty replicating deep OTM or ITM positions. Therefore, the traders will require compensation for risking their capital and push up the implied vols for these options.Hope this helps,

QuoteOriginally posted by: AnnaBeginsI would disagree with imranyusof's last comment. Thinly traded options should exhibit a greater skew - as traders will have more difficulty replicating deep OTM or ITM positions. Therefore, the traders will require compensation for risking their capital and push up the implied vols for these options.Hope this helps,Yup. I stand corrected. You're right, of course. In other words, just because wing vols for thinly-traded ccy options are rarely (if ever) published, doesn't mean the wing vols don't exist!Cheers.