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.
Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
