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Forecasting Emerging Market Exchange Rates from Foreign Equity Options

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  • Ting‐Heng Chu
  • Steve Swidler

Abstract

The use of derivatives to infer future exchange rates has long been a subject of interest in the international finance literature. With the recent currency crises in Mexico, Southeast Asia, and Brazil, work on exchange rate expectations in emerging markets is of particular interest. For some emerging markets, foreign equity options are the only liquid exchange‐traded derivatives with currency information embedded in their prices. Given that emerging markets sometimes undergo currency realignment with discrete jumps in their exchange rate, estimation of risk‐neutral probability density functions from foreign equity option data provides valuable evidence concerning market expectations. To illustrate the use of foreign equity options in estimating market beliefs, we consider Telmex options around the 1994 peso devaluation and find evidence that markets anticipated the change in the Mexican government's foreign exchange policy.

Suggested Citation

  • Ting‐Heng Chu & Steve Swidler, 2002. "Forecasting Emerging Market Exchange Rates from Foreign Equity Options," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 25(3), pages 353-366, September.
    • Handle: RePEc:bla:jfnres:v:25:y:2002:i:3:p:353-366
    DOI: 10.1111/1475-6803.00023
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    References listed on IDEAS

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    1. Jose M. Campa & P.H. Kevin Chang & James F. Refalo, 1999. "An Options-Based Analysis of Emerging Market Exchange Rate Expectations: Brazil's Real Plan, 1994-1997," NBER Working Papers 6929, National Bureau of Economic Research, Inc.
    2. Jackwerth, Jens Carsten, 1999. "Option Implied Risk-Neutral Distributions and Implied Binomial Trees: A Literature Review," MPRA Paper 11634, University Library of Munich, Germany.
    3. Bhupinder Bahra, 1997. "Implied risk-neutral probability density functions from option prices: theory and application," Bank of England working papers 66, Bank of England.
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