## Central Bank Participation in Currency Options Markets

_IMF Working Papers, October 1, 1999_

## Source details

**Canonical URL:** [Central Bank Participation in Currency Options Markets](https://www.imf.org/en/publications/wp/issues/2016/12/30/central-bank-participation-in-currency-options-markets-3297)

## Other formats

- [Markdown version](/en/publications/wp/issues/2016/12/30/central-bank-participation-in-currency-options-markets-3297/index.md)
- [Structured JSON version](/en/publications/wp/issues/2016/12/30/central-bank-participation-in-currency-options-markets-3297/index.json)
- [Bundle manifest](/en/publications/wp/issues/2016/12/30/central-bank-participation-in-currency-options-markets-3297/bundle-manifest.json)

## Bibliographic details
- Authors: Peter Breuer
- Published: October 1, 1999
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451856101.001

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### 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.

### Analysis and Mechanism
- Central bank action: Participation via currency options, specifically option selling.
- Market-maker response: Dynamic hedging of long option exposure by market makers leads to stabilizing effects on exchange rate movements.
- Instrument compared: Option-selling (strangle) versus spot market interventions.
- Cost and credibility trade-off:
  - Potential benefit: Lower expected cost than spot market interventions.
  - Risk: Unlimited loss potential for the central bank when selling options.

### Policy Implications and Recommendations
- Consider selling option structures (e.g., a “strangle”) to:
  - Lower exchange rate volatility.
  - Increase credibility of an implicit target zone commitment.
  - Potentially reduce expected intervention costs compared with spot interventions.
- Manage and monitor unlimited loss exposure associated with option-selling strategies.

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## Content in this bundle

- **Central Bank Participation in Currency Options Markets - WP/99/140**
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  - [Central Bank Participation in Currency Options Markets - WP/99/140 (PDF)](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/1999/_wp99140.pdf){rel="external" type="application/pdf"}

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/30/central-bank-participation-in-currency-options-markets-3297_