RMB Foreign Exchange Option Market And The Application Of The Option Products

The RMB foreign exchange option has emerged as a new productsince2011. Compared to the sophisticated financial markets of developedcountries, China’s FX market is now in its infancy, and the developmentof RMB FX option products faces many constrains, such as heavyregulation, single products, and a relatively illiquid market etc. The mainpurpose of this paper is to build a holistic view of the RMB FX optionmarket through multi-dimensional analyses and discussions.In order to understand the nature of the RMB FX option products, wegeneralize the development history and the pricing mechanism of theRMB FX market, which is under a managed floating exchange rate regimebased on the market demand and supply with reference to a basket ofcurrencies, and then summarize the regulatory policies, trading rules aswell as the current situation of the RMB FX option market. We alsoelaborate the features of three different types of RMB option markets,defined as CNY option market, CNH option market and RMB non-deliverable option market (NDO) respectively, all of which areformed in the RMB’s internationalization process, and point out theimplied arbitrary mechanism between these markets. Based on thefundamentals discussed above, we conclude a few major influencingfactors of the RMB volatility, which are the expected RMB FX rate, thelinkages between the onshore and offshore markets, and the demand ofthe customers.To put the theory into practice, the method of empirical analysis isused to price the RMB FX option products in onshore and offshoremarkets, the main application of which is to increase the profits of thedesigned portfolio. The popular risk hedging methods and the currentdifficulties in the onshore market are also illustrated. Finally, somesuggestions about the development of the onshore RMB FX optionmarket are provided.