EconStor >
Bank of Canada, Ottawa >
Bank of Canada Discussion Papers >

Please use this identifier to cite or link to this item:

http://hdl.handle.net/10419/66967
  
Title:Market expectations and option prices: Evidence for the Can$/US$ exchange rate PDF Logo
Authors:García, Alejandro
Prokopiw, Andrei
Issue Date:2010
Series/Report no.:Bank of Canada Discussion Paper 2010-2
Abstract:Security prices contain valuable information that can be used to make a wide variety of economic decisions. To extract this information, a model is required that relates market prices to the desired information, and that ideally can be implemented using timely and low-cost methods. The authors explore two models applied to option prices to extract the risk-neutral probability density function (R-PDF) of the expected Can$/US$ exchange rate. Each of the two models extends the Black-Scholes model by using a mixture of two lognormals for the terminal distribution, instead of a single lognormal: one mixed lognormal imposes a specific stochastic process for the underlying asset, and the other does not. The contribution of the paper is to propose a simple methodology to build R-PDFs with a constant time to maturity in the absence of option prices for the maturity of interest. The authors apply this methodology and find that the two models provide similar results for the degree of uncertainty (i.e., the variance) surrounding the future level of the exchange rate, but differ on the likely direction of the exchange rate movements (i.e., the skewness).
Subjects:Exchange rates
Econometric and statistical methods
Financial markets
JEL:C00
C02
G13
Document Type:Working Paper
Appears in Collections:Bank of Canada Discussion Papers

Files in This Item:
File Description SizeFormat
623482150.pdf315.88 kBAdobe PDF
No. of Downloads: Counter Stats
Download bibliographical data as: BibTeX
Share on:http://hdl.handle.net/10419/66967

Items in EconStor are protected by copyright, with all rights reserved, unless otherwise indicated.