Pricing of Currency Options in Credible Exchange Rate Target Zones: an Extension and an Alternative Valuation Approach
The paper examines pricing of options on target zone exchange rates. The pricing model of Dumas, Jennergren and Näslund (1993) is extended to asymmetric burden sharing in the defence of the target zone. This extension is relevant for various realistic set-ups, such as unilateral target zones. The paper also introduces an alternative pricing model that, in the tradition of Black and Scholes (1973), starts from geometric Brownian motion in which, however, the target zone limits are explicitly taken account of. This approach has a strong appeal from the practical point of view as it is less demanding in terms of required pricing inputs. This, however, goes at the cost of ignoring target zone nonlinearities. Simulations show that the simpler alternative model in most relevant cases moderately underprices by 1% to 3%.
|Date of creation:||Mar 2000|
|Date of revision:|
|Contact details of provider:|| Postal: Naamsestraat 69, 3000 Leuven|
Phone: +32-(0)16-32 67 25
Fax: +32-(0)16-32 67 96
Web page: http://www.econ.kuleuven.be/ew
More information through EDIRC
When requesting a correction, please mention this item's handle: RePEc:ete:ceswps:ces0031. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Karla Vander Weyden)
If references are entirely missing, you can add them using this form.