Option-implied volatility spillover indices for FX risk factors

•We propose a new econometric method to model implied portfolio volatility spillovers.•Orthogonal FX risk factors are state-dependent correlated in the second moments.•High spillover states coincides with times of economic turbulence.

This study employs option price data to back out the implied portfolio volatilities of the dollar and carry trade risk factors of the G-10 currencies. We construct a forward-looking option-implied volatility spillover index. Our findings indicate that the dollar and carry trade risk factors are orthogonal in the first moment and exhibit strong stochastic interrelations in the second expected moment.