Using copulas to construct bivariate foreign exchange distributions with an application to the sterling exchange rate index
By: Matthew Hurd, Mark Salmon, and Christoph Schleicher.
Contributors: Salmon, Mark.; Schleicher, Christoph.; Bank of England.
Series: Working paper -- no. 334; Working paper (Bank of England : Online) -- no. 334.
Publisher: Bank of England
Published: 2007
Place of publication: London
Language: eng
Description: "We model the joint risk-neutral distribution of the euro-sterling and the dollar-sterling exchange  rates using option-implied marginal distributions that are connected via a copula function that  satisfies the triangular no-arbitrage condition. We then derive a univariate distribution for a  simplified sterling effective exchange rate index. Our results indicate that standard parametric  copula functions, such as the commonly used Normal and Frank copulas, fail to capture the degree  of asymmetry observed in the data. We overcome this problem by using a non-parametric  dependence function in the form of a Bernstein copula which is shown to produce a very close fit.  We further give an example of how our approach can be used to price currency index options."--Bank of England web site.
Notes: Title from PDF file as viewed on Feb. 4, 2008.

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