Bundled Risks, Dollar Index Options, and Quantitative Implications for Dynamic Currency Models

Abstract

We propose a model of options on futures on the dollar index, which are traded vehicles to protect against concerted U.S. dollar appreciations or depreciations. Estimating the model, we draw quantitative assessments and examine consistency with our empirical findings. First, average excess returns for out-of-the-money (OTM) call options on dollar index futures are negative and statistically significant, whereas those for OTM put options are insignificant. Second, average excess returns for call options become more negative at higher strikes. The estimated model adheres to the data on dollar index option prices, volatilities, and supports negative risk premiums for OTM call options.

Keywords: Traded bundled risks, model of options on futures on the dollar index, formulation of dollar index option risk premiums, returns of options on futures on the dollar index, dynamic models of currency behavior

JEL Classification: G11, G12, G13, C5, D24, D34.