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Arbitrage-Based Tests of Target Zone Credibility: Evidence from ERM Cross-Rate Options

Author

Listed:
  • Campa, J.M.
  • Chang, P.H.K.

Abstract

This paper introduces two arbitrage-based tests of target-zone credibility using a new data source, exchange-rate mechanism cross-rate options. Using daily option prices from September 1991 to August 1994, the authors assess the credibility of the pound-mark and mark-lira target zones that collapsed in September 1992 and the ongoing mark-French franc target zone. These tests are based on restrictions that must apply to all option prices within a credible target zone and are free from specification error and estimation error. The authors also identify a minimum 'intensity of realignment,' an expression indicating the probability-weighted average realignment size. Copyright 1996 by American Economic Association.
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Suggested Citation

  • Campa, J.M. & Chang, P.H.K., 1995. "Arbitrage-Based Tests of Target Zone Credibility: Evidence from ERM Cross-Rate Options," Papers 95-25, Columbia - Graduate School of Business.
  • Handle: RePEc:fth:colubu:95-25
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    Keywords

    EXCHANGE RATE; FORECASTS; ECONOMETRICS; CURRENCIES; INTERNATIONAL FINANCE;
    All these keywords.

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F39 - International Economics - - International Finance - - - Other

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