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On the exit value of a forward contract
Author(s) -
Power Gabriel J.,
Turvey Calum G.
Publication year - 2009
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.20350
Subject(s) - forward contract , martingale (probability theory) , put option , hedge , economics , call option , actuarial science , valuation of options , value (mathematics) , financial economics , econometrics , forward price , futures contract , mathematics , statistics , ecology , biology
Default risk associated with forward contracts can be substantial, yet these financial instruments are widely used to hedge price risk. An objectively priced exit option on the forward contract would help reduce the likelihood of litigation associated with contract default. A method is proposed to compute the exit option's value for an arbitrary forward contract, using Black's (1976) model and option premium data. The time series dynamics of the exit option value are confirmed to be, like its underlying, well described by a martingale with heavy‐tailed (Student) GARCH residuals. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 29: 179–196, 2009