Option-implied probability distributions and currency excess returns
By: Allan M. Malz.
Contributors: Federal Reserve Bank of New York.
Series: Staff reports ;; no. 32; Staff reports (Federal Reserve Bank of New York : Online) ;; no. 32.
Publisher: Federal Reserve Bank of New York
Published: 1997
Place of publication: [New York, N.Y.]
Language: eng
Format: Electronic resource
Subjects: Options (Finance) -- Econometric models.; Foreign exchange rates -- Econometric models.; Distribution (Probability theory)
Description: "This paper describes a method of extracting the risk-neutral probability distribution of future exchange rates from option prices.  In foreign exchange markets interbank option pricing conventions make possible reliable inferences about risk-neutral probability distributions with relatively little data.  Moments drawn from risk-neutral exchange rate distribution are used to explore several issues related to the puzzle of excess returns in currency markets.  Tests of the international capital asset pricing model using risk-neutral moments as explanatory variables indicate that option-based moments have considerably greater explanatory power for excess returns in currency markets than has been found in earlier work.  Tests of several hypotheses generated by the peso problem approach indicate that jump risk measured by the risk-neutral coefficient of skewness can explain only a small part of the forward bias.  These tests take into account not only the second, but the third and fourth moments of the exchange rate implied by option prices, and avoid testing a joint hypothesis including a distributional assumption"--Federal Reserve Bank of New York web site.
Notes: Also available in print.
Includes bibliographical references.
Title from PDF file as viewed on 2/1/2005.
System requirements: Adobe Acrobat Reader.
Mode of access: World Wide Web.