Reference no: EM134791 , Length: 70
Dissertation writing help - Intrinsic Currency Values
This is related to quantitative finance - Custom Dissertation Writing Service
People normally say that some currency has strengthened or weakened but what do they mean? Against what does one measure the currency values? Can we de ne intrinsic value of a currency?
In quantitative finance the conventional practice is to model currency movements as changes in FX rates. It was shown by Doust and Chen in a series of articles how to model intrinsic currency values instead. Their first model assumed multivariate log-normal distribution of a set of currency values with volatilities and correlations being fixed.
Their latest model is significantly more complex but shows how multiple currencies can be modelled consistently with all market-observed FX implied volatility surfaces. They have proposed maximum likelihood estimation for the intrinsic values in the original model. But can it be adapted for the new model? And do the currency values implied by these models correspond to what is observed in FX and other markets? Can we use intrinsic values to explain and/or predict unrelated market indicators?
In the first part of this work we extend the maximum likelihood estimation of intrinsic values to the latest model called 'stochastic intrinsic currency volatility framework' by making some assumptions about the distribution. We then analyze the performance of the extended solution. Unfortunately, due to complexity of the model, we do not have analytic bounds for the error. We had to resort to Monte-Carlo simulation to investigate the properties of the new estimation approach. We find that the new estimation approach is theoretically better than the original one but empirically the difference is insignificant. We also present the results of estimating intrinsic values of 8 currencies: USD, EUR, JPY, GBP, CHF, CAD, AUD, NZD, using both approaches and see that the story they tell correspond to recent financial history and market participants' intuition.
In the second part we analyze the currency value estimates further, checking for links with various markets, including interest rates, stock market indices, sovereign credit default swap spreads and VIX equity volatility index. These are the markets which did not feed any inputs to our model. What we find is that there are still links between intrinsic currency values and these seemingly unrelated markets.