An exact pricing formula for European call options on zero-coupon bonds in the run-up to a currency union
AbstractIn this paper we analyze the dynamics of zero-coupon bond options in a situation in which two open economies plan to enter a currency union in the future. More precisely, we make use of recent theoretical work on the continuous-time dynamics of interest-rate differentials between the economies involved and derive a closed-form pricing formula for a European call option on zero-coupon bonds. In a Monte-Carlo simulation study we show that significant option-pricing errors can occur when the key features of interest-rate dynamics during the run-up to the currency union are ignored.
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Bibliographic InfoPaper provided by Center for Quantitative Economics (CQE), University of Muenster in its series CQE Working Papers with number 1010.
Length: 31 pages
Date of creation: Jan 2010
Date of revision:
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Postal: Am Stadtgraben 9, 48143 Münster, Germany
Web page: http://www1.wiwi.uni-muenster.de/cqe/
More information through EDIRC
Interest-rate dynamics; valuation of interest-rate options; currency union;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
- E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
- F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-02-13 (All new papers)
- NEP-CFN-2010-02-13 (Corporate Finance)
- NEP-MON-2010-02-13 (Monetary Economics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- De Grauwe, Paul & Dewachter, Hans & Veestraeten, Dirk, 1999. "Price dynamics under stochastic process switching: some extensions and an application to EMU1," Journal of International Money and Finance, Elsevier, vol. 18(2), pages 195-224, February.
- David Sondermann & Mark Trede & Bernd Wilfling, 2011. "Estimating the degree of interventionist policies in the run-up to EMU," Applied Economics, Taylor & Francis Journals, vol. 43(2), pages 207-218.
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