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A class of quadratic options for exchange rate stabilization

  • Suh, Sangwon
  • Zapatero, Fernando

We propose the use of a new option which we call 'quadratic,' and that central banks could use to smooth exchange rate volatility through the hedging strategies of the issuers. We derive analytic pricing and hedging formulas. We suggest a criterion to derive the optimal (for the Central Bank) option parameters. Finally, we perform several simulation exercises which show the effectiveness of using this option, with or without conventional spot interventions.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 32 (2008)
Issue (Month): 11 (November)
Pages: 3478-3501

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Handle: RePEc:eee:dyncon:v:32:y:2008:i:11:p:3478-3501
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  1. Dominguez, Kathryn M & Frankel, Jeffrey A, 1993. "Does Foreign-Exchange Intervention Matter? The Portfolio Effect," American Economic Review, American Economic Association, vol. 83(5), pages 1356-69, December.
  2. Priscilla Chiu, 2003. "Transparency versus constructive ambiguity in foreign exchange intervention," BIS Working Papers 144, Bank for International Settlements.
  3. Liliana Schumacher & Mario I. Bléjer, 2000. "Central Banks Use of Derivatives and Other Contingent Liabilities; Analytical Issues and Policy Implications," IMF Working Papers 00/66, International Monetary Fund.
  4. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  5. Hung, Juann H, 1997. "Intervention strategies and exchange rate volatility: a noise trading perspective," Journal of International Money and Finance, Elsevier, vol. 16(5), pages 779-793, September.
  6. Bhattacharya, Utpal & Weller, Paul, 1992. "The Advantage to Hiding One's Hand: Speculation and Central Bank Intervention in the Foreign Exchange Market," CEPR Discussion Papers 737, C.E.P.R. Discussion Papers.
  7. Garman, Mark B. & Kohlhagen, Steven W., 1983. "Foreign currency option values," Journal of International Money and Finance, Elsevier, vol. 2(3), pages 231-237, December.
  8. Jonathan Eaton & Stephen J. Turnovsky, 1983. "The Forward Exchange Market, Speculation, and Exchange Market Intervention," NBER Working Papers 1138, National Bureau of Economic Research, Inc.
  9. Peter Breuer, 1999. "Central Bank Participation in Currency Options Markets," IMF Working Papers 99/140, International Monetary Fund.
  10. Vitale, Paolo, 1999. "Sterilised central bank intervention in the foreign exchange market," Journal of International Economics, Elsevier, vol. 49(2), pages 245-267, December.
  11. Dowd, Kevin, 1994. "A Proposal to End Inflation," Economic Journal, Royal Economic Society, vol. 104(425), pages 828-40, July.
  12. Zapatero, Fernando & Reverter, Luis F., 2003. "Exchange rate intervention with options," Journal of International Money and Finance, Elsevier, vol. 22(2), pages 289-306, April.
  13. Christopher J. Neely, 2001. "The practice of central bank intervention: looking under the hood," Review, Federal Reserve Bank of St. Louis, issue May, pages 1-10.
  14. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  15. Ousmène Mandeng, 2003. "Central Bank Foreign Exchange Market Intervention and Option Contract Specification; The Case of Colombia," IMF Working Papers 03/135, International Monetary Fund.
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