Central Bank Participation in Currency Options Markets

Author/Editor:

Peter Breuer

Publication Date:

October 1, 1999

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

This paper analyzes whether and how central banks can use currency options to lower exchange rate volatility and maintain (implicit) target zones in foreign exchange markets. It argues that selling rather than buying options will result in market makers dynamically hedging their long option exposure in a stabilizing manner, consistent with the first objective. Selling a “strangle” allows a central bank to increase the credibility of its commitment to a target zone, and could have a lower expected cost than spot market interventions. However, this strategy also exposes the central bank to an unlimited loss potential.

Series:

Working Paper No. 99/140

Subject:

English

Publication Date:

October 1, 1999

ISBN/ISSN:

9781451856101/1018-5941

Stock No:

WPIEA1401999

Format:

Paper

Pages:

40

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