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Valuing Foreign Currency Options with a Mean-Reverting Process: A Study of Hong Kong Dollar

Author

Listed:
  • Cho-hoi Hui

    (Research Department, Hong Kong Monetary Authority)

  • Vincent Yeung

    (Research Department, Hong Kong Monetary Authority)

  • Laurence Fung

    (Research Department, Hong Kong Monetary Authority)

  • Chi-Fai Lo

    (Research Department, Hong Kong Monetary Authority)

Abstract

The theoretical prediction of target exchange rates expects mean reversion of the exchange rates. This paper presents a model for valuing European foreign exchange options, in which the forward foreign exchange rate follows a mean-reverting lognormal process. The mean-reverting process has material impact on the foreign exchange rate option values and their hedge parameters. The numerical results using the forward exchange rates of the Hong Kong dollar and market data of their options show such impact. As the dynamics of target exchange rates may not follow the standard lognormal process as described by the Black-Scholes model, the mean-reverting option-pricing model may be considered for valuation of options and estimation of associated hedge parameters on target exchange rates.

Suggested Citation

  • Cho-hoi Hui & Vincent Yeung & Laurence Fung & Chi-Fai Lo, 2007. "Valuing Foreign Currency Options with a Mean-Reverting Process: A Study of Hong Kong Dollar," Working Papers 0708, Hong Kong Monetary Authority.
    • Handle: RePEc:hkg:wpaper:0708
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    File URL: http://www.info.gov.hk/hkma/eng/research/working/pdf/HKMAWP07_08_full.pdf
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    Cited by:

    1. Ledenyov, Dimitri O. & Ledenyov, Viktor O., 2015. "Wave function method to forecast foreign currencies exchange rates at ultra high frequency electronic trading in foreign currencies exchange markets," MPRA Paper 67470, University Library of Munich, Germany.

    More about this item

    Keywords

    Target foreign exchange rates; currency options; mean-reverting process;
    All these keywords.

    JEL classification:

    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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