Noise Trading, Central Bank Interventions, and the Informational Content of Foreign Currency Options
Springer Science & Business Media, Dec 6, 2001 - Business & Economics - 207 pages
A flexible instrument to insure against adverse exchange rate movements are options on foreign currency. Often a relatively simple foreign currency option valuation model is used to address issues related to the pricing and hedging of such options. The results of many empirical studies document that real-world foreign currency option premia deviate from those predicted by the baseline model. In the first part of the book, it is shown that a noise trader model can help to explain the observed mispricing of the baseline foreign currency option pricing model. In the second part of the book, it is studied how policymakers can exploit the pricing errors of the baseline model. In particular, it is examined how option pricing theory can be applied to assess the effectiveness of central bank interventions in the foreign exchange market. To this end, a model is constructed to analyze the effectiveness of the interventions conducted by the Deutsche Bundesbank during the Louvre period.
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American option asset price boundary conditions Bundesbank central bank central bank interventions chartists coefficient conditional exchange rate conditional volatility contingent claim valuation currency option pricing currency pairs derived discussed domestic currency dummy variable economic fundamentals empirical estimated exchange rate process exchange rate returns exchange rate volatility Figure foreign currency option foreign exchange market fundamentalists FX market interventions FX option pricing GARCH models GK model impact implicit in foreign implicit price barriers implicit trading regimes implicit trading triggers implied volatility in-the-money instantaneous volatility interest rate interval market participants moneyness moving average noise traders numerical option pricing model option valuation model ordered probit ordered probit model parameter premium probit model real-world risk-free risk-free interest rates risk-neutral Section simulation spot market spot rate stochastic volatility strategy success criterion technical traders test for implicit theoretical trading behavior trading thresholds underlying US/DM utilized valuation equation volatilities implicit volatility smile volatility strike structure volatility-based test