Analogy Based Valuation of Currency Options


The two most intriguing anomalies in currency markets are: 1) the implied volatility smile in currency options, and 2) the forward discount bias in currency exchange rates. I show that if currency options are valued in analogy with the underlying currency and beliefs are heterogeneous, then the forward discount bias causes the smile. The analogy based currency option pricing formula is put forward, which converges to Garman-Kohlhagen formula if there is no forward discount bias. In the presence of the forward discount bias, an increase in belief dispersion increases the slope as well as the curvature of the smile

Similar works

Full text


Munich RePEc Personal Archive

Provided a free PDF
oai::62333Last time updated on 7/9/2019View original full text link

This paper was published in Munich RePEc Personal Archive.

Having an issue?

Is data on this page outdated, violates copyrights or anything else? Report the problem now and we will take corresponding actions after reviewing your request.