Arbitrage-free affine models of the forward price of foreign currency

J. Benson Durham

Forward foreign exchange contracts embed not only expected depreciation but also a sizable premium, which complicates inferences about anticipated returns. This study derives arbitrage-free affine forward currency models (AFCMs) with closed-form expressions for both unobservable variables. Model calibration to forward term structures of eleven U.S.-dollar currency pairs from the mid-to-late 1990s through early 2014 fits the data closely and suggests that the premium is indeed nonzero and variable, but not to the degree implied by previous econometric studies.

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Year of publication:	2014
Authors:	Durham, J. Benson
Publisher:	New York, NY : Federal Reserve Bank of New York
Subject:	arbitrage-free model \| foreign exchange \| Währungsderivat \| Currency derivative \| CAPM \| Zinsstruktur \| Yield curve \| Wechselkurs \| Exchange rate \| Arbitrage Pricing \| Arbitrage pricing \| Optionspreistheorie \| Option pricing theory