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Currency Option Pricing in Credible Target Zones

  • Bernard Dumas
  • L. Peter Jennergren
  • Bertil Naslund

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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File URL: http://www.nber.org/papers/w4522.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4522.

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Date of creation: Nov 1993
Date of revision:
Publication status: published as Review of Futures Markets, Vol. 12, No. 2, pp. 323-346. (April 1992)
Handle: RePEc:nbr:nberwo:4522
Note: AP IFM
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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Web page: http://www.nber.org
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  1. Maurice Obstfeld & Alan C. Stockman, 1983. "Exchange-Rate Dynamics," NBER Working Papers 1230, National Bureau of Economic Research, Inc.
  2. Lars E. O. Svensson, 1990. "Target Zones and Interest Rate Variability," IMF Working Papers 90/31, International Monetary Fund.
  3. Paul R. Krugman, 1988. "Target Zones and Exchange Rate Dynamics," NBER Working Papers 2481, National Bureau of Economic Research, Inc.
  4. 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.
  5. Bertola, G. & Svensson, L.E., 1990. "Stochastic Devaluation Risk and the Empirical Fit of Target Zone Models," Papers 481, Stockholm - International Economic Studies.
  6. 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.
  7. 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.
  8. 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.
  9. 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.
  10. Lindbecg, H. Soderlind, P., 1992. "Target Zone Models and the Intervention Policy; The Swedish Case," Papers 496, Stockholm - International Economic Studies.
  11. Flood, Robert P & Garber, Peter M, 1991. "The Linkage between Speculative Attack and Target Zone Models of Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 106(4), pages 1367-72, November.
  12. 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.
  13. Donald J. Mathieson & Robert P. Flood & Andrew K. Rose, 1991. "An Empirical Exploration of Exchange Rate Target-Zones," IMF Working Papers 91/15, International Monetary Fund.
  14. 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.
  15. Lindberg, H. & Soderlind, P., 1991. "Testing the Basic Target Zone Model on Swedish Data," Papers 488, Stockholm - International Economic Studies.
  16. 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.
  17. Paul Krugman & Marcus Miller, 1992. "Exchange Rate Targets and Currency Bands," NBER Books, National Bureau of Economic Research, Inc, number krug92-1, August.
  18. 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.
  19. 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.
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