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Forward Exchange Price Determination in Continuous Time

Published online by Cambridge University Press:  19 October 2009

Extract

The work of Black and Scholes [2] and Merton [4] suggests that analysis of hedged positions in a continuous time random walk model yields powerful insights into the valuation of financial securities. The present paper extends this methodology in a straightforward fashion to foreign exchange transactions. By adopting the device of hedging in a secondary market for forward currency contracts against a long position in spot currency, a simple statement of boundary conditions for the forward position can be detailed. This allows a direct solution of the continuous time valuation problem that yields the interest rate parity theory.

Type
Research Article
Copyright
Copyright © School of Business Administration, University of Washington 1977

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References

REFERENCES

[1]Black, Fischer. “The Pricing of Commodity Contracts.” Journal of Financial Economics, Vol. 3 (January/March 1976).CrossRefGoogle Scholar
[2]Black, Fischer, and Scholes, Myron. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, Vol. 81 (May/June 1973), pp. 637654.CrossRefGoogle Scholar
[3]Cummins, Philip A.; Logue, Dennis E.; Sweeney, Richard James; and Willett, Thomas D.. “Aspects of Efficiency in the U.S./Canadian Foreign Exchange Market.” Unpublished paper (October 1975).Google Scholar
[4]Merton, Robert C.The Theory of Rational Option Pricing.” The Bell Journal of Economics and Management Science, Vol. 4 (Spring 1973), pp. 141183.CrossRefGoogle Scholar
[5]Westerfield, Janice M. A Theoretical and Empirical Examination of Risk in the Foreign Exchange Markets. Ph.D. dissertation, University of Pennsylvania (1974).Google Scholar