Currency Crisis Prediction Using ADR Market Data - An Options-Based Approach
28 Pages Posted: 8 Mar 2008
Date Written: March 4, 2008
During capital control episodes, large price deviations between American Depositary Receipts (ADR) and their underlying stocks signal that a currency crisis is about to occur. We interpret this price spread as the price of a call option. Using option pricing theory we derive detailed information about both the probability of a currency crisis and the expected magnitude of devaluation. Analyzing daily ADR market data preceding the Venezuelan crisis (1996), our approach predicts crisis probabilities of almost 100% and forecasts the exchange rate after floating quite accurately. During the Argentine crisis (2002), estimated exchange rates are similar to actual ones.
Keywords: Currency Crisis Prediction, ADR, Stock markets, Options approach
JEL Classification: F 34, F35, G15
Suggested Citation: Suggested Citation