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Derivative Pricing Based On The Exchange Rate In A Target Zone With Realignment

Author

Listed:
  • LIJUN BO

    (Department of Mathematics, Xidian University, Xi'an 710071, P. R. China)

  • YONGJIN WANG

    (School of Business, Nankai University, Tianjin 300071, P. R. China)

  • XUEWEI YANG

    (School of Mathematical Sciences, Nankai University, Tianjin 300071, P. R. China)

Abstract

We propose a tractable model for the exchange rate in a target zone with realignment. The target zone exchange rate dynamics is assumed to obey a bounded regular diffusion with two-sided unattainable barriers. The realignment is modeled as a continuous-time two-state Markov chain. Under the stationary setting of the Markov chain, a general pricing formula for the derivative written on the exchange rate is derived in the presence of the realignment risk. The Jacobi diffusion model is studied as an example and numerical results are presented for illustration.

Suggested Citation

  • Lijun Bo & Yongjin Wang & Xuewei Yang, 2011. "Derivative Pricing Based On The Exchange Rate In A Target Zone With Realignment," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 14(06), pages 945-956.
    • Handle: RePEc:wsi:ijtafx:v:14:y:2011:i:06:n:s0219024911006796
    DOI: 10.1142/S0219024911006796
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    Cited by:

    1. Feng, Liming & Jiang, Pingping & Wang, Yongjin, 2020. "Constant elasticity of variance models with target zones," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 537(C).

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