| Abstract: | It is well documented that exchange rate volatility is time-varying and that it can be affected by scheduled events such as money supply announcements and unscheduled ones such as spot market interventions and interest rate changes. This study provides a European event model (E model) for currency call options that explicitly addresses the volatility effects of these two classes of events. Managers who are concerned with hedging in an environment of changing volatility may find the E model useful. The E and modified Black-Scholes (MBS) models have similar average errors in predicting option price changes across event windows and do better than a naive no-change prediction. The E model tends to reduce the underpricing of convex, short-term out-of-the-money options and the mispricing of most classes of convex options. |
