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- Publisher
- Emerald Publishing
- Copyright
- Copyright © Emerald Group Publishing Limited
- ISSN
- 0307-4358
- DOI
- 10.1108/eb013677
- Publisher site
- See Article on Publisher Site
Abstract
Since the early 1980s, currency options have become a popular means for hedging foreign currency positions or speculating on anticipated movements in exchange rates. Yet, they can also be used to enhance the forecasting of exchange rates. Corporate forecasts of exchange rates involve two tasks 1 a point estimate of a currency's exchange rate, and 2 a confidence interval that suggests the degree of uncertainty associated with the point estimate forecast. A currency forward or futures price is often used as the point estimate required. The confidence interval is commonly developed by using the historical volatility of exchange rate movements. However, an alternative method is to use the market's anticipated volatility in developing the confidence interval. Scott and Tucker 1990 have shown that the volatility implied from contemporaneous currency option prices is a better forecast of future volatility than historical measures. Therefore, a confidence interval implied by currency options should also be more reliable. Our objective is to illustrate how confidence intervals can be developed from currency option information. Given the degree of difficulty in forecasting exchange rates, more reliable confidence intervals could greatly improve managerial decisions.
Journal
Managerial Finance – Emerald Publishing
Published: Apr 1, 1991