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Arbitrage-Based Tests of Target-Zone Credibility: Evidence from ERM Cross-Rate Options

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Author Info
Campa, Jose Manuel
Chang, P H Kevin

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Abstract

This paper introduces two arbitrage-based tests of target-zone credibility using a new data source, exchange-rate mechanism cross-rate options. Using daily option prices from September 1991 to August 1994, the authors assess the credibility of the pound-mark and mark-lira target zones that collapsed in September 1992 and the ongoing mark-French franc target zone. These tests are based on restrictions that must apply to all option prices within a credible target zone and are free from specification error and estimation error. The authors also identify a minimum 'intensity of realignment,' an expression indicating the probability-weighted average realignment size. Copyright 1996 by American Economic Association.

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Publisher Info
Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 86 (1996)
Issue (Month): 4 (September)
Pages: 726-40
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Handle: RePEc:aea:aecrev:v:86:y:1996:i:4:p:726-40

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  1. Markus Haas & Stefan Mittnik & Bruce Mizrach, 2005. "Assessing Central Bank Credibility During the ERM Crises: Comparing Option and Spot Market-Based Forecasts," CFS Working Paper Series 2005/09, Center for Financial Studies. [Downloadable!]
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  2. Eichengreen, Barry, 2001. "The EMS Crisis in Retrospect," CEPR Discussion Papers 2704, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  3. Mundaca, Gabriela, 2003. "A Drift of the "Drift Adjustment Method"," Memorandum 16/2002, Oslo University, Department of Economics. [Downloadable!]
  4. David Backus & Silverio Foresi & Liuren Wu, 2002. "Accouting for Biases in Black-Scholes," Finance 0207008, EconWPA. [Downloadable!]
  5. W Buiter & G Corsetti & P Pesenti, 1997. "Interpreting the ERM Crisis: Country-Specific and Systemic Issues," CEP Discussion Papers 0321, Centre for Economic Performance, LSE. [Downloadable!]
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  6. Campa, José Manuel, 2000. "Exchange Rates and Trade: How Important is Hysteresis in Trade?," CEPR Discussion Papers 2606, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  7. Jose Manuel Campa & P.H. Kevin Chang, 1996. "Options-based evidence of the credibility of the peseta in the ERM," Investigaciones Economicas, Fundación SEPI, vol. 20(1), pages 3-22, January. [Downloadable!]
  8. Mody, Ashoka & Taylor, Mark P, 2003. "Common Vulnerabilities," CEPR Discussion Papers 3759, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  9. Jose M. Campa & P.H. Kevin Chang & Robert L. Reider, 1997. "Implied Exchange Rate Distributions: Evidence from OTC Option Markets," NBER Working Papers 6179, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. Bronka Rzepkowski, 2000. "The Expectations of a Hong Kong Dollar Devaluation and their Determinants," Working Papers 2000-04, CEPII research center. [Downloadable!]
  11. Dean Corbae & Chris Neely & Paul Weller, 1998. "Endogenous realignments and the sustainability of a target," Working Papers 1994-009, Federal Reserve Bank of St. Louis. [Downloadable!]
  12. Jose M. Campa & P. H. Kevin Chang, 1997. "The Forecasting Ability of Correlations Implied in Foreign Exchange Options," NBER Working Papers 5974, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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