Munich Personal RePEc Archive

Explaining the Smile in Currency Options: Is it Anchoring?

Siddiqi, Hammad (2015): Explaining the Smile in Currency Options: Is it Anchoring?

[img]
Preview
PDF
MPRA_paper_63528.pdf

Download (664kB) | Preview

Abstract

An anchoring adjusted currency option pricing formula is developed in which the risk of the underlying currency is used as a starting point which gets adjusted upwards to arrive at the currency call risk. Anchoring bias implies that such adjustments are insufficient. The new formula converges to the Garman-Kohlhagen formula in the absence of anchoring bias. Anchoring bias generates the implied volatility smile if investors hold heterogeneous exchange rate expectations.

UB_LMU-Logo
MPRA is a RePEc service hosted by
the Munich University Library in Germany.