An Explicit Mapping of Currency Target Zone Models to Option Prices

5 Pages Posted: 16 Nov 2017

See all articles by Sandro Claudio Lera

Sandro Claudio Lera

MIT Media Lab

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC); Swiss Finance Institute

Date Written: November 14, 2017

Abstract

Currency target zones have been under scrutiny for the past three decades, which led to the development of two broad classes of quantitative models: Phenomenological ones that explicitly take into consideration the market’s perception of the bounded exchange rate, and more mechanical ones that rely on put and call options. Until now, the two models have only been compared qualitatively. Here, we derive, for the first time, a quantitative link between these two approaches. Specifically, we show how the former approach has to be generalized in order to recover the second one. This mapping lets us relate the phenomenological parameter of the first approach to economically well-known quantities.

Keywords: exchange rate dynamics, target zones, option pricing

JEL Classification: E50, E51, E52, E58

Suggested Citation

Lera, Sandro Claudio and Sornette, Didier, An Explicit Mapping of Currency Target Zone Models to Option Prices (November 14, 2017). Available at SSRN: https://ssrn.com/abstract=3070399 or http://dx.doi.org/10.2139/ssrn.3070399

Sandro Claudio Lera (Contact Author)

MIT Media Lab ( email )

77 Massachusetts Avenue
Cambridge, MA 02139
United States

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC) ( email )

Scheuchzerstrasse 7
Zurich, ZURICH CH-8092
Switzerland
41446328917 (Phone)
41446321914 (Fax)

HOME PAGE: http://www.er.ethz.ch/

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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