The correlation structure of FX option markets before and since the financial crisis

The liquidity crunch and the ensuing financial crisis have unambiguously affected all national economies and global currency exchange rates. In this article we ask whether the cross-currency correlation structure has changed since 2007. Using an extensive set of volatility surfaces implied from over-the-counter options on 11 different exchange rates, as well as recent advances in static and dynamic factor models, we are able to show that the number of factors that innovate the correlation structure has not changed in the last two and a half years. It is the volatility, the persistence and the significance of global systematic factors, vis-a-vis regional or economy-specific ones, that appear to have changed dramatically. The implications for the risk management of currency exposures and for the predictability of exchange rate volatility are also outlined.