A Note on Estimating Realignment Probabilities -- A First-Passage-Time Approach
AbstractThis paper proposes a path-dependent approach for estimating realignment probabilities of targeted exchange rates based on first-passage-time distributions instead of the commonly used path-independent approach. We consider that path dependency is an intrinsic characteristic of realignment risk because a realignment of an exchange rate can occur whenever a committed band by a central bank is breached. A mean-reverting lognormal process is considered in the first-passage-time approach. Based on market data of the British pound and mark during the ERM crisis of 1992, the realignment probabilities of the pound estimated under the proposed approach show that path dependency is quantitatively significant, compared with the path-independent approach.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Hong Kong Monetary Authority in its series Working Papers with number 0809.
Length: 15 pages
Date of creation: Jun 2008
Date of revision:
Contact details of provider:
Postal: 55th Floor, Two International Finance Centre, 8 Finance Street, Central
Web page: http://www.info.gov.hk/hkma/
More information through EDIRC
realignment risk; mean-reversion; first-passage-time probability;
Find related papers by JEL classification:
- F31 - International Economics - - International Finance - - - Foreign Exchange
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-07-30 (All new papers)
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.:
- Clifford Ball & Antonio Roma, 1998. "Detecting mean reversion within reflecting barriers: application to the European Exchange Rate Mechanism," Applied Mathematical Finance, Taylor & Francis Journals, Taylor & Francis Journals, vol. 5(1), pages 1-15.
- Fred G M C Nieuwland & Willem F C Verschoor & Christian C P Wolff, 1990. "EMS Exchange Rates," CEPR Financial Markets Paper, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ 0002, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ.
- Ball, Clifford A & Torous, Walter N, 1985. " On Jumps in Common Stock Prices and Their Impact on Call Option Pricing," Journal of Finance, American Finance Association, American Finance Association, vol. 40(1), pages 155-73, March.
- Krugman, Paul R, 1991.
"Target Zones and Exchange Rate Dynamics,"
The Quarterly Journal of Economics, MIT Press,
MIT Press, vol. 106(3), pages 669-82, August.
- Svensson, Lars E. O., 1993.
"Assessing target zone credibility : Mean reversion and devaluation expectations in the ERM, 1979-1992,"
European Economic Review, Elsevier,
Elsevier, vol. 37(4), pages 763-793, May.
- Lars E.O. Svensson, 1991. "Assessing Target Zone Credibility: Mean Reversion and Devaluation Expectations in the ERM 1979-1992," NBER Working Papers 3795, National Bureau of Economic Research, Inc.
- Ball, Clifford A. & Roma, Antonio, 1994. "Target zone modelling and estimation for European Monetary System exchange rates," Journal of Empirical Finance, Elsevier, Elsevier, vol. 1(3-4), pages 385-420, July.
- Ball, Clifford A. & Roma, Antonio, 1993. "A jump diffusion model for the European monetary system," Journal of International Money and Finance, Elsevier, Elsevier, vol. 12(5), pages 475-492, October.
- Anthony, Myrvin & MacDonald, Ronald, 1999. "The width of the band and exchange rate mean-reversion: some further ERM-based results," Journal of International Money and Finance, Elsevier, Elsevier, vol. 18(3), pages 411-428.
- Bates, David S., 1996. "Dollar jump fears, 1984-1992: distributional abnormalities implicit in currency futures options," Journal of International Money and Finance, Elsevier, Elsevier, vol. 15(1), pages 65-93, February.
- Angelos Kanas, 1998. "Testing for a unit root in ERM exchange rates in the presence of structural breaks: evidence from the bootstrap," Applied Economics Letters, Taylor & Francis Journals, Taylor & Francis Journals, vol. 5(7), pages 407-410.
- Campa, Jose Manuel & Chang, P H Kevin, 1996.
"Arbitrage-Based Tests of Target-Zone Credibility: Evidence from ERM Cross-Rate Options,"
American Economic Review, American Economic Association,
American Economic Association, vol. 86(4), pages 726-40, September.
- Campa, J.M. & Chang, P.H.K., 1995. "Arbitrage-Based Tests of Target Zone Credibility: Evidence from ERM Cross-Rate Options," Papers, Columbia - Graduate School of Business 95-25, Columbia - Graduate School of Business.
- Ball, Clifford A. & Torous, Walter N., 1983. "A Simplified Jump Process for Common Stock Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 18(01), pages 53-65, March.
- Malz, Allan M., 1996. "Using option prices to estimate realignment probabilities in the European Monetary System: the case of sterling-mark," Journal of International Money and Finance, Elsevier, Elsevier, vol. 15(5), pages 717-748, October.
- Genberg, Hans & Hui, Cho-Hoi, 2008.
"The credibility of 'The Link' from the perspective of modern financial theory,"
IMFS Working Paper Series, Institute for Monetary and Financial Stability (IMFS), Goethe University Frankfurt
18, Institute for Monetary and Financial Stability (IMFS), Goethe University Frankfurt.
- Hans Genberg & Cho-hoi Hui, 2009. "The Credibility of the Link from the Perspective of Modern Financial Theory," Working Papers, Hong Kong Monetary Authority 0902, Hong Kong Monetary Authority.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Simon Chan).
If references are entirely missing, you can add them using this form.