Valuation of early exercise premium on currency options: The put-call parity approach revisited

Previous studies on American options have shown that European style models do not reflect early exercise premium (EEP). This project expands on the Poitras, Veld and Zabolotnyuk (2006) paper which applies the put-call parity method to currency options data from American options traded at PHLX for EEP. We define a wider range for in-the moneyness and use a rolling volatility for the volatility parameter. We estimate the early exercise premium as a percentage of option price (REEP) for calls and puts to be 7.329%, 6.122%, respectively. We then regress the REEP against moneyness, interest differentials, and time to maturity and volatility. Our results show that REEP is strongly and positively correlated with interest rate differentials and time to maturity. The effect of moneyness is less apparent. The effect of volatility on REEPs of put options is significantly negative, which coincides with the results of Poitras, Veld and Zabolotnyuk (2006)