TY  - JOUR
AU  - Campa,Jose M.
AU  - Chang,P.H. Kevin
AU  - Reider,Robert L.
TI  - Implied Exchange Rate Distributions: Evidence from OTC Option Markets
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 6179
PY  - 1997
Y2  - September 1997
UR  - http://www.nber.org/papers/w6179
L1  - http://www.nber.org/papers/w6179.pdf
N1  - Author contact info:
Jose M. Campa
IESE Business School
Camino del Cerro del Aguila, 3
28023 Madrid
SPAIN
Tel: 34-91-357-0809
Fax: 34-91-357-2913
E-Mail: jcampa@iese.edu
AB  - This paper uses a rich new data set of option prices on the dollar-mark, dollar-yen, and key EMS cross-rates to extract the entire risk-neutral probability density function (pdf) over horizons of one and three months. We compare three alternative smoothing methods---cubic splines, an implied binomial tree (trimmed and untrimmed), and a mixture of lognormals---for transforming option data into the pdf.  Despite their methodological ifferences, the three approaches lead to a similar pdf distinct from the lognormal benchmark, and usually characterized by skewness and leptokurtosis. We then document a striking positive correlation between skewness in these pdfs and the spot rate.  The stronger a currency the more expectations are skewed towards a further appreciation of that currency. We interpret this finding as a rejection that these exchange rates evolve as a martingale, or that they follow a credible target zone, explicit or implicit.  Instead, this this positive correlation is consistent with target zones with endogenous realignment risk.  We discuss two interpretations of our results on skewness: when a currency is stronger, the actual probability of further large appreciation is higher, or because of risk, such states are valued more highly.
ER  -