Efficiency of the foreign currency options market

This paper provides a new test of the efficiency of the currency option markets for four major currencies - British Pound, Euro, Swiss Frank and Japanese Yen vis-à-vis the U.S. dollar. The approach is to simulate trading strategies to see if the well-accepted no-arbitrage condition of put-call parity (PCP) holds in a trading environment. Augmented Dickey-Fuller and Philips-Perron tests are used to check for the presence of unit roots in the data, followed by a formal econometric analysis. The results indicate that the most currency option prices do not violate the PCP conditions, when transaction costs are allowed for.