ERM Realignment Risk and Its Economic Determinants as Reflected in Cross-Rate Options
AbstractThis paper uses data on over-the-counter options between the mark and the pound, lira, French franc, and peseta to investigate the credibility of exchange rate target zones within the exchange rate mechanism. The authors compare empirical implications for the relation between option prices and the spot's position within the band for three classes of target zone models: those with full credibility, those with exogenous realignment risk, and those with endogenous realignment risk. Empirically, implied volatility from these options attains a maximum near the edges of an exchange rate band rather than its center, even three to six months prior to realignment.
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Bibliographic InfoArticle provided by Royal Economic Society in its journal The Economic Journal.
Volume (Year): 108 (1998)
Issue (Month): 449 (July)
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- Guimarães, Bernardo, 2007. "Currency Crisis Triggers: Sunspots or Thresholds?," CEPR Discussion Papers 6487, C.E.P.R. Discussion Papers.
- Inci, Ahmet Can, 2005. "ERM effects on currency spot and futures markets," Global Finance Journal, Elsevier, vol. 16(2), pages 145-163, December.
- Martin Mandler, 2002. "Extracting Market Expectations from Option Prices: Two Case Studies in Market Perceptions of the ECB's Monetary Policy 1999/2000," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 138(II), pages 165-189, June.
- Mundaca, Gabriela, 2003. "A Drift of the "Drift Adjustment Method"," Memorandum 16/2002, Oslo University, Department of Economics.
- Driessen, Joost & Perotti, Enrico C, 2004. "Confidence Building on Euro Conversion: Theory and Evidence from Currency Options," CEPR Discussion Papers 4180, C.E.P.R. Discussion Papers.
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