Central Bank Participation in Currency Options Markets

October 1, 1999

Preview Citation

Format: Chicago

Peter Breuer. Central Bank Participation in Currency Options Markets, (USA: International Monetary Fund, 1999) accessed September 19, 2024

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.

Subject: Asset prices, Banking, Currencies, Exchange rates, Financial institutions, Financial regulation and supervision, Foreign exchange, Hedging, Money, Options, Prices

Keywords: Asset prices, Central bank intervention, Currencies, Currency options, Dynamic hedging, Exchange rates, Global, Hedging, Option exposure, Option market, Option position, Option price, Options, Options transaction, Spot market intervention, WP

Publication Details

Pages:

40
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 1999/140
Stock No:

WPIEA1401999
ISBN:

9781451856101
ISSN:

1018-5941

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