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Currency Option Pricing in Credible Target Zones

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  • Bernard Dumas
  • L. Peter Jennergren
  • Bertil Naslund

Abstract

This paper develops a model for valuing options on a currency which is maintained within a band. The starting point of our model is the well known Krugman model for exchange-rate behavior within a target zone. Results from model runs provide insight into evidence reported by other authors of mispricing of currency options by extensions of the Black-Scholes model.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4522.

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Date of creation: Nov 1993
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Publication status: published as Review of Futures Markets, Vol. 12, No. 2, pp. 323-346. (April 1992)
Handle: RePEc:nbr:nberwo:4522

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  1. Lars E.O. Svensson, 1989. "Target Zones and Interest Rate Variability," NBER Working Papers 3218, National Bureau of Economic Research, Inc.
  2. Bodurtha, James N. & Courtadon, Georges R., 1987. "Tests of an American Option Pricing Model on the Foreign Currency Options Market," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 22(02), pages 153-167, June.
  3. Francisco Delgado & Bernard Dumas, 1990. "Monetary Contracting Between Central Banks and the Design of SustainableExchange-Rate Zones," NBER Working Papers 3440, National Bureau of Economic Research, Inc.
  4. Dumas, Bernard & Peter Jennergren, L. & Naslund, Bertil, 1995. "Realignment risk and currency option pricing in target zones," European Economic Review, Elsevier, Elsevier, vol. 39(8), pages 1523-1544, October.
  5. Giuseppe Bertola & Lars E.O. Svensson, 1991. "Stochastic Devaluation Risk and the Empirical Fit of Target Zone Models," NBER Working Papers 3576, National Bureau of Economic Research, Inc.
  6. Flood, Robert P. & Rose, Andrew K. & Mathieson, Donald J., 1991. "An empirical exploration of exchange-rate target-zones," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 35(1), pages 7-65, January.
  7. Merton, Robert C., 1976. "Option pricing when underlying stock returns are discontinuous," Journal of Financial Economics, Elsevier, Elsevier, vol. 3(1-2), pages 125-144.
  8. Paul Krugman & Marcus Miller, 1992. "Exchange Rate Targets and Currency Bands," NBER Books, National Bureau of Economic Research, Inc, number krug92-1, July.
  9. 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.
  10. Philippe Jorion, 1988. "On Jump Processes in the Foreign Exchange and Stock Markets," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 1(4), pages 427-445.
  11. Garman, Mark B. & Kohlhagen, Steven W., 1983. "Foreign currency option values," Journal of International Money and Finance, Elsevier, Elsevier, vol. 2(3), pages 231-237, December.
  12. Delgado, F. & Dumas, B., 1990. "Monetary Contracting Between Central Banks And The Design Of Sustainable Exchange-Rate Zones," Weiss Center Working Papers, Wharton School - Weiss Center for International Financial Research 20-90, Wharton School - Weiss Center for International Financial Research.
  13. Flood, Robert P & Garber, Peter M, 1991. "The Linkage between Speculative Attack and Target Zone Models of Exchange Rates," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 106(4), pages 1367-72, November.
  14. Obstfeld, Maurice & Stockman, Alan C., 1985. "Exchange-rate dynamics," Handbook of International Economics, Elsevier, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 18, pages 917-977 Elsevier.
  15. Lindberg, H. & Soderlind, P., 1991. "Testing the Basic Target Zone Model on Swedish Data," Papers, Stockholm - International Economic Studies 488, Stockholm - International Economic Studies.
  16. Eduardo R. Borensztein & Michael P. Dooley, 1987. "Options on Foreign Exchange and Exchange Rate Expectations," IMF Staff Papers, Palgrave Macmillan, vol. 34(4), pages 643-680, December.
  17. Delgado, F. & Dumas, B., 1990. "Monetary Contracting Between Central Banks And The Design Of Sustainable Exchange-Rate Zones," The Warwick Economics Research Paper Series (TWERPS), University of Warwick, Department of Economics 360, University of Warwick, Department of Economics.
  18. Francisco Delgado & Bernard Dumas, . "Monetary Contracting between Central Banks and the Design of Sustainable Exchange-Rate Zones (Reprint 035)," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 20-90, Wharton School Rodney L. White Center for Financial Research.
  19. Lindbecg, H. Soderlind, P., 1992. "Target Zone Models and the Intervention Policy; The Swedish Case," Papers, Stockholm - International Economic Studies 496, Stockholm - International Economic Studies.
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Cited by:
  1. Ekvall, Niklas & Peter Jennergren, L. & Naslund, Bertil, 1997. "Currency option pricing with mean reversion and uncovered interest parity: A revision of the Garman-Kohlhagen model," European Journal of Operational Research, Elsevier, Elsevier, vol. 100(1), pages 41-59, July.
  2. Dibeh, Ghassan, 2006. "Target zone dynamics where the fundamental follows a SDE with periodic forcing," Physica A: Statistical Mechanics and its Applications, Elsevier, Elsevier, vol. 363(2), pages 437-445.
  3. Mordecai Avriel & Jens Hilscher & Alon Raviv, 2012. "Inflation Derivatives Under Inflation Target Regimes," Working Papers, Brandeis University, Department of Economics and International Businesss School 43, Brandeis University, Department of Economics and International Businesss School.
  4. Mundaca, Gabriela, 2003. "A Drift of the "Drift Adjustment Method"," Memorandum, Oslo University, Department of Economics 16/2002, Oslo University, Department of Economics.
  5. Christian Pierdzioch, 2000. "The Effectiveness of the FX Market Interventions of the Bundesbank During the Louvre Period: An Options-Based Analysis," Kiel Working Papers 971, Kiel Institute for the World Economy.
  6. Naszódi, Anna, 2002. "A sávos árfolyamú deviza megközelítése opciók segítségével
    [The option-based description of the exchange rate in a target-zone system]
    ," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(1), pages 25-44.
  7. Bernard Dumas & L. Peter Jennergren & Bertil Naslund, 1993. "Realignment Risk and Currency Option Pricing in Target Zones," NBER Working Papers 4458, National Bureau of Economic Research, Inc.
  8. Naszódi, Anna, 2004. "A sáveltolás árfolyamhatásának vizsgálata opciós modell keretei között
    [Target-zone rearrangement and exchange-rate behaviour in an options-based model]
    ," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(7), pages 638-658.

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