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Equilibrium Valuation of Foreign Exchange Claims
Author(s) -
BAKSHI GURDIP S.,
CHEN ZHIWU
Publication year - 1997
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1997.tb04822.x
Subject(s) - economics , futures contract , currency , valuation (finance) , comparative statics , hedge , foreign exchange risk , exchange rate , econometrics , interest rate , stochastic volatility , foreign exchange , interest rate parity , volatility (finance) , financial economics , mathematical economics , monetary economics , microeconomics , finance , ecology , biology
This article studies the equilibrium valuation of foreign exchange contingent claims. Within a continuous‐time Lucas (1982) two‐country model, exchange rates, interest rates and, in particular, factor risk prices are all endogenously and jointly determined. This guarantees the internal consistency of these price processes with a general equilibrium. In the same model, closed‐form valuation formulas are presented for currency options and currency futures options. Common to these formulas is that stochastic volatility and stochastic interest rates are admitted. Hedge ratios and other comparative statics are also provided analytically. It is shown that most existing currency option models are included as special cases.