| Author: | Malz, A. M. |
| Title: | Using option prices to estimate realignment probabilities in the European Monetary System : the case of sterling-mark |
| Journal: | Journal of International Money and Finance
1996 : OCT, VOL. 15:5, p. 717-748 |
| Index terms: | ASSETS EXCHANGE RATES EUROPEAN MONETARY SYSTEM |
| Language: | eng |
| Abstract: | This paper describes a procedure for estimating the market's perceived probability distribution of future exchange rates from the prices of risk reversals, strangles and other currency options, and uses the procedure to estimate the risk neutral ex ante probability of a realignment of the pound sterling. The procedure for estimating the realignment probabilities relies on the jump-diffusion model of exchange rate behavior and the resulting option pricing formula. By fitting this model to market option price data, the unobserved parameters of the jump-diffusion process are retrieved. Then these parameter estimates are used to estimate the ex ante probability distribution of exchange rates and thus the realignment probabilities. |
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