On the Credibility of the Euro/Swiss Franc Floor: A Financial Market Perspective

Abstract

The sheer existence of EUR/CHF put options with strike prices below the 1.20 EUR/CHF floor, trading at non-zero cost, challenged the full credibility of the Swiss National Bank (SNB) in enforcing the lower barrier implemented in September 6, 2011 and abandoned on January 15, 2015. We estimate the risk-neutral break probabilities of a realignment of the floor from market prices of put options, using an extension of the Veestraeten option pricing model which assumes that the underlying security price exhibits a lower barrier. We show that these probabilities were considerably different from zero over long time intervals, even when the exchange rate traded far above the 1.20 EUR/CHF floor. We observe a drastic increase in the break-probabilities after August 2014, reaching a level of nearly 50%, which was the level before the announcement of the details of the "Draghi put" in September 2012. The credibility of the SNB in maintaining the floor, as seen from the option market, was thus substantially lower than publicly claimed.

Keywords: central banking, credibility, currency option, Euro/Swiss Franc floor, Vanna-Volga method, barrier

JEL Classification: E42, E58, F31, G13