Download or read book Implied Exchange Rate Distributions written by José Campa and published by . This book was released on 1997 with total page 64 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper uses a rich new data set of option prices on the dollar-mark, dollar-yen, and key EMS cross-rates to extract the entire risk-neutral probability density function (pdf) over horizons of one and three months. We compare three alternative smoothing methods--cubic splines, an implied binomial tree (trimmed and untrimmed), and a mixture of lognormals--for transforming option data into the pdf. Despite their methodological ifferences, the three approaches lead to a similar pdf distinct from the lognormal benchmark, and usually characterized by skewness and leptokurtosis. We then document a striking positive correlation between skewness in these pdfs and the spot rate. The stronger a currency the more expectations are skewed towards a further appreciation of that currency. We interpret this finding as a rejection that these exchange rates evolve as a martingale, or that they follow a credible target zone, explicit or implicit. Instead, this this positive correlation is consistent with target zones with endogenous realignment risk. We discuss two interpretations of our results on skewness: when a currency is stronger, the actual probability of further large appreciation is higher, or because of risk, such states are valued more highly.