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Regime-Switching in Foreign Exchange Rates: Evidence from . . . (2000)
| Venue: | Journal of Econometrics |
| Citations: | 19 - 0 self |
BibTeX
@ARTICLE{Bollen00regime-switchingin,
author = {N.P.B. Bollen and Stephen F. Gray and Robert E. Whaley},
title = {Regime-Switching in Foreign Exchange Rates: Evidence from . . .},
journal = {Journal of Econometrics},
year = {2000},
volume = {94},
pages = {239--276}
}
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Abstract
This paper examines the ability of regime-switching models to capture the dynamics of foreign exchange rates. First we test the ability of the models to fit foreign exchange rate data in-sample and forecast variance out-of-sample. A regime-switching model with independent shifts in mean and variance exhibits a closer fit and more accurate variance forecasts than a range of other models. Next we use exchange-traded currency options to determine whether market prices reflect regime-switching information. We find that observed option prices are significantly different from their theoretical levels determined by a regime-switching option valuation model and that a simulated trading strategy based on regime-switching option valuation generates higher profits than standard single-regime alternatives. Overall, the results indicate that observed option prices do not fully reflect regime-switching information. Last revised: May 8, 1998 1 REGIME-SWITCHING IN FOREIGN EXCHANGE RATES: EVIDENCE ...
Keyphrases
foreign exchange rate option price regime-switching model regime-switching information market price regime-switching option valuation forecast variance independent shift accurate variance forecast regime-switching foreign exchange rate theoretical level simulated trading strategy exchange-traded currency option standard single-regime alternative foreign exchange rate data in-sample variance exhibit regime-switching option valuation model
