Realignment Risk and Currency Option Pricing in Target Zones

Bernard Dumas (), Peter Jennergren and Bertil Naslund

No 4458, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper extends the Krugman target zone model by including a realignment mechanism. Various properties of that realignment mechanism are discussed. The movement of the exchange rate is governed both by a Wiener process on fundamental and by a Poisson jump process with endogenous realignment size. The realignment mechanism is such that (except in cases where a speculative attack occurs) no jump in fundamental is needed to accompany the jump in the exchange rate. A risk neutral valuation of currency options is constructed. Some properties of option values under realignment risk are illustrated by numerical results.

JEL-codes: F31 G13 (search for similar items in EconPapers)
Date: 1993-09
Note: AP IFM
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Published as European Economic Review, Vol. 39, (1995), pp. 1523-1566.

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Related works:
Journal Article: Realignment risk and currency option pricing in target zones (1995)
Working Paper: Realignment risk and currency option pricing in target zones (1993)
Working Paper: Realignment risk and currency option pricing in target zones (1992)
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