EconPapers    
Economics at your fingertips  
 

Valuing foreign currency options with a mean-reverting process: a study of Hong Kong dollar

C. H. Hui, C. F. Lo, V. Yeung and L. Fung
Additional contact information
C. H. Hui: Research Department, Hong Kong Monetary Authority, Two International Finance Centre, Central, Hong Kong, China, Postal: Research Department, Hong Kong Monetary Authority, Two International Finance Centre, Central, Hong Kong, China
C. F. Lo: Institute of Theoretical Physics and Department of Physics, The Chinese University of Hong Kong, Shatin, N.T., Hong Kong, China, Postal: Institute of Theoretical Physics and Department of Physics, The Chinese University of Hong Kong, Shatin, N.T., Hong Kong, China
V. Yeung: Research Department, Hong Kong Monetary Authority, Two International Finance Centre, Central, Hong Kong, China, Postal: Research Department, Hong Kong Monetary Authority, Two International Finance Centre, Central, Hong Kong, China
L. Fung: Research Department, Hong Kong Monetary Authority, Two International Finance Centre, Central, Hong Kong, China, Postal: Research Department, Hong Kong Monetary Authority, Two International Finance Centre, Central, Hong Kong, China

International Journal of Finance & Economics, 2008, vol. 13, issue 1, 118-134

Abstract: The theoretical prediction on targeted exchange rates expects mean reversion of the exchange rates. There is some empirical evidence to support this prediction. This paper presents a model for valuing European foreign exchange options in which the forward foreign exchange rate follows a mean-reverting lognormal process. The corresponding closed-form solutions for the option valuation are derived. The mean-reverting process has material impact on the foreign exchange rate option values and their hedge parameters. This tends to decrease the value of a simple put or call. On the other hand, the process also keeps the exchange rate in a small range around the mean level. As this is the region in which an option's intrinsic value is high because of the level of its strike price, there is also a tendency for option values to be enhanced compared with the values of the Black-Scholes model. The numerical results using the forward exchange rates of the Hong Kong dollar and market data of their options show that both of these effects are important for the realistic choices of parameter values. As the dynamics of targeted exchange rates may not follow the standard lognormal process as described by the Black-Scholes model, the mean-reverting option-pricing model may be considered for the valuation of options and estimation of associated hedge parameters on targeted exchange rates. Copyright © 2007 John Wiley & Sons, Ltd.

Date: 2008
References: View references in EconPapers View complete reference list from CitEc
Citations View citations in EconPapers (1) Track citations by RSS feed

Downloads: (external link)
http://hdl.handle.net/10.1002/ijfe.346 Link to full text; subscription required (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ijf:ijfiec:v:13:y:2008:i:1:p:118-134

Ordering information: This journal article can be ordered from
http://jws-edcv.wile ... PRINT_ISSN=1076-9307

Access Statistics for this article

International Journal of Finance & Economics is currently edited by Mark P. Taylor, Keith Cuthbertson and Michael P. Dooley

More articles in International Journal of Finance & Economics from John Wiley & Sons, Ltd.
Series data maintained by Wiley-Blackwell Digital Licensing ().

 
Page updated 2017-12-30
Handle: RePEc:ijf:ijfiec:v:13:y:2008:i:1:p:118-134