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Options on Foreign Exchange and Exchange Rate Expectations

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  • Eduardo R. Borensztein

    (International Monetary Fund)

  • Michael P. Dooley

    (International Monetary Fund)

Abstract

This paper tests alternative assumptions concerning the time-series behavior of foreign exchange rates. Data for about 20,000 individual trades on foreign exchange options for dollar exchange rates against six major currencies carried out from February 1983 to June 1985 are analyzed. The tests carried out suggest that, judging from the predictions of a model of options prices based on the assumption that exchange rates follow a diffusion process, market participants paid too high a price for call options that would have been profitable only if the dollar depreciated substantially within a short time period. An alternative model which allows for discrete jumps in exchange rates is found to be more consistent with the data.

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Bibliographic Info

Article provided by Palgrave Macmillan in its journal Staff Papers - International Monetary Fund.

Volume (Year): 34 (1987)
Issue (Month): 4 (December)
Pages: 643-680

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Handle: RePEc:pal:imfstp:v:34:y:1987:i:4:p:643-680

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Cited by:
  1. Bernard Dumas & L. Peter Jennergren & Bertil Naslund, 1993. "Currency Option Pricing in Credible Target Zones," NBER Working Papers 4522, National Bureau of Economic Research, Inc.
  2. Shang-Jin Wei & Jeffrey A. Frankel, 1991. "Are Option-Implied Forecasts of Exchange Rate Volatility Excessively Variable?," NBER Working Papers 3910, National Bureau of Economic Research, Inc.

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