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Recovering risk-neutral densities from exchange rate options: Evidence from Lira-Dollar options

Author

Listed:
  • Halil İbrahim AYDIN

    (Merkez Bankası)

  • Ahmet DEĞERLİ

    (Merkez Bankası)

  • Pınar ÖZLÜ

    (Merkez Bankası)

Abstract

This paper uses over-the-counter currency options data to investigate market expectations on Turkish Lira-U.S. Dollar exchange rate. We extract option implied density functions to examine the evolution of market sentiment over the possible values of future exchange rates. Uncertainty is well measured by option-implied probabilities. Estimated densities for selected days point out an increase in uncertainty in foreign exchange market during financial turbulence periods. We make inferences about the effectiveness of policy measures and see how the market perception changed throughout the crisis. We uncover the effectiveness of policy measures by observing shrinking densities and confidence bands.

Suggested Citation

  • Halil İbrahim AYDIN & Ahmet DEĞERLİ & Pınar ÖZLÜ, 2010. "Recovering risk-neutral densities from exchange rate options: Evidence from Lira-Dollar options," Iktisat Isletme ve Finans, Bilgesel Yayincilik, vol. 25(291), pages 9-26.
  • Handle: RePEc:iif:iifjrn:v:25:y:2010:i:291:p:9-26
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    Cited by:

    1. Değerli, Ahmet & Fendoğlu, Salih, 2015. "Reserve option mechanism as a stabilizing policy tool: Evidence from exchange rate expectations," International Review of Economics & Finance, Elsevier, vol. 35(C), pages 166-179.

    More about this item

    Keywords

    Options; Risk neutral density; Market expectations.;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G19 - Financial Economics - - General Financial Markets - - - Other
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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