Target zone rearrangements and exchange rate behavior in an options-based model
AbstractThis paper sets up an options-based model of the exchange rate in a target zone system according to which the observed exchange rate is equivalent to a floating exchange rate adjusted with the value of two options. The strike prices of the options are the limits of the band, but the two options are interrelated which complicates their evaluation. Within this framework, the direct effect of the band rearrangement on the exchange rate can be measured by the change of the option prices caused by the change of the strike prices. We apply this options-based model to analyze the depreciation of the forint in the summer of 2003. Depreciation is decomposed into (a) the direct effect of the band-shift; (b) changing expectations relating the final conversation rate in the EMU; and (c) changing uncertainty. Exchange rate changes of some European currencies due to band rearrangements is also analyzed.
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Bibliographic InfoPaper provided by Magyar Nemzeti Bank (the central bank of Hungary) in its series MNB Working Papers with number 2004/2.
Length: 36 pages
Date of creation: 2004
Date of revision:
target zone system; options; option pricing; target zone rearrangement; band-shift; band widening.;
Find related papers by JEL classification:
- F31 - International Economics - - International Finance - - - Foreign Exchange
- F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
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