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The Relative Valuation of American Currency Spot and Futures Options: Theory and Empirical Tests

Joseph P. Ogden and Alan L. Tucker
The Journal of Financial and Quantitative Analysis
Vol. 23, No. 4 (Dec., 1988), pp. 351-368
DOI: 10.2307/2331076
Stable URL: http://www.jstor.org/stable/2331076
Page Count: 18
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Since scans are not currently available to screen readers, please contact JSTOR User Support for access. We'll provide a PDF copy for your screen reader.
The Relative Valuation of American Currency Spot and Futures Options: Theory and Empirical Tests
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Abstract

This study empirically tests contingent claims pricing models for American currency spot and futures options. Numerical analysis indicates that the difference in the model prices of spot and futures put (call) options (with the same exercise price and maturity) is, for a premium (discount) currency, positive and an increasing function of (a) the absolute difference in the prices of the underlying spot and futures contracts and (b) the maturity of the options. Tests on British pound, Deutsche mark, and Swiss franc options indicate many violations of the ordinal pricing relationship noted above. Additional tests indicate that option prices are inconsistent with functional relationship (b) above. Most of the observed violations are sufficiently large to provide arbitrage profits net of transaction costs, assuming interest rates and constant and the Interest Rate Parity theorem holds continuously. Alternatively, both the violations and the inconsistent functional relationship may be due to violation of the assumption of constant interest rates.

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