Can Exchange Rate Dynamics in Krugman's Target-Zone Model Be Directly Tested?

2016 ◽  
Author(s):  
C. H. Hui ◽  
Chi-Fai Lo ◽  
Po-Hon Chau
Keyword(s):  
Exchange Rate ◽  
Zone Model ◽  
Target Zone ◽  
Exchange Rate Dynamics

DERIVATIVE PRICING BASED ON THE EXCHANGE RATE IN A TARGET ZONE WITH REALIGNMENT

2011 ◽  
Vol 14 (06) ◽  
pp. 945-956 ◽  
Author(s):  
LIJUN BO ◽  
YONGJIN WANG ◽  
XUEWEI YANG
Keyword(s):  
Markov Chain ◽  
Exchange Rate ◽  
Diffusion Model ◽  
Continuous Time ◽  
Numerical Results ◽  
Derivative Pricing ◽  
Target Zone ◽  
Exchange Rate Dynamics ◽  
The Exchange Rate ◽  
Pricing Formula

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.

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