Booms and Busts as Exchange Options
35 Pages Posted: 19 Jun 2015
There are 2 versions of this paper
Booms and Busts as Exchange Options
Date Written: June 17, 2015
Abstract
Selling (buying) a country’s equity index in exchange for equity investments elsewhere during a stock market crash (boom) is analogous to exercising an option to exchange an underperforming country (global benchmark) index for a global benchmark (country) index. This can be shown by extending an existing single factor option pricing framework to determine the exchange option value of entering and exiting an emerging market. As country betas, corrected for non-synchronous trading bias, rise during the Asian Crisis and fall thereafter, exit option values on average increase by at least 14 cents per dollar invested for each unit increase in country betas during the first stage of the crisis in 1997. Exit option values on average rise by 29 cents per dollar invested during the last stage in January 1999. So even if the benefits of diversification fall during a crisis, the effects of a crisis might be hedged.
Keywords: Country Systematic Risk and Risk-Adjusted Performance; Exchange Options; International Transmission; Net Capital Flow Monitoring; Non-synchronous Trading Bias
JEL Classification: F30; F36; G2; G15
Suggested Citation: Suggested Citation