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Currency Options and Trade Smoothing under an Exchange Rate Regime Shift

In: Exchange Rate Policies, Prices and Supply-Side Response

Author

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  • Alexis Derviz

Abstract

This chapter describes a dynamic stochastic model of investment, production and consumption in an open economy. Equilibrium supplies and demands for goods and securities are obtained under the assumption of optimally behaving producers, exporters, importers, households and foreign investors. These supplies and demands are derived in terms of their shadow prices, which are adjoint processes of the optimization problems of the agents. The shadow prices prove to be diffusion processes with parameters expressed in terms of utilities, production functions, and asset returns and growth/goods attrition rates. Therefore, the equilibrium trade volumes and prices may have non-stationary characteristics. Accordingly, problems may arise if one attempts to estimate time series for prices directly. It is more natural to estimate the dynamics of the shadow prices and derive from them the predictions of price behaviour, including the effects of real exchange rate and other exogenous shocks.

Suggested Citation

  • Alexis Derviz, 2001. "Currency Options and Trade Smoothing under an Exchange Rate Regime Shift," Palgrave Macmillan Books, in: Christos Papazoglou & Eric J. Pentecost (ed.), Exchange Rate Policies, Prices and Supply-Side Response, chapter 3, pages 24-53, Palgrave Macmillan.
    • Handle: RePEc:pal:palchp:978-0-230-55453-5_3
    DOI: 10.1057/9780230554535_3
    as

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