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Extracting market expectations from option prices: an application to over-the-counter New Zealand dollar options

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Author Info
Aron Gereben (Reserve Bank of New Zealand)

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Abstract

What are the odds of a large shift in the exchange rate? Is a large depreciation more likely than a large appreciation? This paper uses over-the-counter New Zealand dollar/US dollar option prices to quantify market expectations of exchange rate uncertainty through measures based on risk-neutral probability distribution functions. Results suggest that the estimated probability distributions can provide important insights into market perceptions about exchange rate risk in the future. Econometric evidence indicates that the higher moments calculated from risk-neutral probability density functions can be used to explain the dynamic behaviour of the forward bias measured in the New Zealand dollar/US dollar exchange rate.

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Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number DP2002/04.

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Length: 23p
Date of creation: Apr 2002
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Handle: RePEc:nzb:nzbdps:2002/04

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Find related papers by JEL classification:
F31 - International Economics - - International Finance - - - Foreign Exchange
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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References listed on IDEAS
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.:
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    Other versions:
  2. Rubinstein, Mark, 1994. " Implied Binomial Trees," Journal of Finance, American Finance Association, vol. 49(3), pages 771-818, July. [Downloadable!] (restricted)
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  6. Robert R Bliss & Nikolaos Panigirtzoglou, . "Testing the stability of implied probability density functions," Bank of England working papers 114, Bank of England. [Downloadable!]
  7. Yuong Ha & Michael Reddell, 1998. "What do forward interest and exchange rates tell us?," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 61, June. [Downloadable!]
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  13. Lyons, Richard K., 1988. "Tests of the foreign exchange risk premium using the expected second moments implied by option pricing," Journal of International Money and Finance, Elsevier, vol. 7(1), pages 91-108, March. [Downloadable!] (restricted)
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Cited by:
(explanations, 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.)

  1. Aron Gereben, 2002. "Extracting market expectations from option prices?," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 65, March. [Downloadable!]
  2. Martin Cincibuch & David Vavra, 2004. "Testing for the uncovered interest parity using distributions implied by FX options," Money Macro and Finance (MMF) Research Group Conference 2003 16, Money Macro and Finance Research Group. [Downloadable!]
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