How Credible is Hong Kong's Currency Peg?

This paper develops an asset-pricing model to evaluate the credibility of Hong Kong’s Linked Exchange Rate System (LERS). Allowing for imperfect peg credibility, we derive closed-form solutions for exchange rates and option prices under potential regime shifts. Using HKD option data, we estimate market-implied probabilities of peg survival and the fundamental value of the HKD. Our results show that credibility fluctuates with U.S. interest rate hikes, local liquidity conditions, and Chinese currency dynamics. Compared with more standard Black-Scholes-based models, our approach provides more realistic assessments of peg sustainability.