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Currency Option Pricing in Credible Target Zones

  • Dumas, B.
  • Jennergren, L.P.
  • Naslund, B.

This paper develops a model for valuing options on a currency which is maintained within a band. The starting point of our model is the well known Krugman model for exchange-rate behavior within a target zone. Results from model runs provide insight into evidence reported by other authors of mispricing of currency options by extensions of the Black-Scholes model.

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Paper provided by Wharton School - Weiss Center for International Financial Research in its series Weiss Center Working Papers with number 93-7.

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Length: 16 pages
Date of creation: 1993
Date of revision:
Handle: RePEc:fth:pennif:93-7
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  1. Dumas, Bernard & Peter Jennergren, L. & Naslund, Bertil, 1995. "Realignment risk and currency option pricing in target zones," European Economic Review, Elsevier, vol. 39(8), pages 1523-1544, October.
  2. Robert P. Flood & Andrew K. Rose & Donald J. Mathieson, 1990. "An Empirical Exploration of Exchange Rate Target-Zones," NBER Working Papers 3543, National Bureau of Economic Research, Inc.
  3. Bernard Dumas & Lars Peter Jennergren & Bertil Näslund, 1992. "Realignment risk and currency option pricing in target zones," Working Papers hal-00611598, HAL.
  4. Lindbecg, H. Soderlind, P., 1992. "Target Zone Models and the Intervention Policy; The Swedish Case," Papers 496, Stockholm - International Economic Studies.
  5. Bertola, Giuseppe & Svensson, Lars E O, 1991. "Stochastic Devaluation Risk and the Empirical Fit of Target Zone Models," CEPR Discussion Papers 513, C.E.P.R. Discussion Papers.
  6. Svensson, L.E.O., 1989. "Target Zones And Interest Rate Variability," Papers 457, Stockholm - International Economic Studies.
  7. Francisco Delgado & Bernard Dumas, 1990. "Monetary Contracting Between Central Banks and the Design of SustainableExchange-Rate Zones," NBER Working Papers 3440, National Bureau of Economic Research, Inc.
  8. Robert P. Flood & Peter M. Garber, 1991. "The Linkage Between Speculative Attack and Target Zone Models of Exchange Rates," The Quarterly Journal of Economics, Oxford University Press, vol. 106(4), pages 1367-1372.
  9. 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.
  10. Delgado, F. & Dumas, B., 1990. "Monetary Contracting Between Central Banks And The Design Of Sustainable Exchange-Rate Zones," Weiss Center Working Papers 20-90, Wharton School - Weiss Center for International Financial Research.
  11. Bodurtha, James N. & Courtadon, Georges R., 1987. "Tests of an American Option Pricing Model on the Foreign Currency Options Market," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(02), pages 153-167, June.
  12. Merton, Robert C., 1975. "Option pricing when underlying stock returns are discontinuous," Working papers 787-75., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  13. Paul Krugman & Marcus Miller, 1992. "Exchange Rate Targets and Currency Bands," NBER Books, National Bureau of Economic Research, Inc, number krug92-1, March.
  14. Delgado, F. & Dumas, B., 1990. "Monetary Contracting Between Central Banks And The Design Of Sustainable Exchange-Rate Zones," The Warwick Economics Research Paper Series (TWERPS) 360, University of Warwick, Department of Economics.
  15. Francisco Delgado & Bernard Dumas, . "Monetary Contracting between Central Banks and the Design of Sustainable Exchange-Rate Zones (Reprint 035)," Rodney L. White Center for Financial Research Working Papers 20-90, Wharton School Rodney L. White Center for Financial Research.
  16. Lindberg, H. & Soderlind, P., 1991. "Testing the Basic Target Zone Model on Swedish Data," Papers 488, Stockholm - International Economic Studies.
  17. Obstfeld, Maurice & Stockman, Alan C., 1985. "Exchange-rate dynamics," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 18, pages 917-977 Elsevier.
  18. Paul R. Krugman, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, Oxford University Press, vol. 106(3), pages 669-682.
  19. Eduardo R. Borensztein & Michael P. Dooley, 1987. "Options on Foreign Exchange and Exchange Rate Expectations," IMF Staff Papers, Palgrave Macmillan, vol. 34(4), pages 643-680, December.
  20. Philippe Jorion, 1988. "On Jump Processes in the Foreign Exchange and Stock Markets," Review of Financial Studies, Society for Financial Studies, vol. 1(4), pages 427-445.
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