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Equilibrium Valuation of Foreign Exchange Claims

Author

Listed:
  • Gurdip S. Bakshi

    (University of Maryland, Robert H. Smith School of Business)

  • Zhiwu Chen

    (International Center for Finance)

Abstract

This paper studies the equilibrium valuation of foreign exchange-contingent claims. The basic framework is the continuous-time counterpart of the classic Lucas (1982) two-country model, in which exchange rates, term structures of interest rates and, in particular, factor risk prices are all endogenously determined and empirically plausible. This endogenous nature guarantees the internal consistency of these price processes with a general equilibrium. In addition to the domestic and foreign nominal interest rates, closed-form valuation formulas are presented for exchange rate options and exchange rate futures options. Common to these formulas is that stochastic volatility and stochastic interest rates are admitted. Hedge ratios and other comparative statistics are provided analytically. It is shown that most existing currency option models are included as special cases.

Suggested Citation

  • Gurdip S. Bakshi & Zhiwu Chen, 1996. "Equilibrium Valuation of Foreign Exchange Claims," Yale School of Management Working Papers ysm51, Yale School of Management.
    • Handle: RePEc:ysm:somwrk:ysm51
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    References listed on IDEAS

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    1. Bick, Avi, 1987. "On the Consistency of the Black-Scholes Model with a General Equilibrium Framework," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(3), pages 259-275, September.
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    More about this item

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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