This short post is inspired by some friends asking whether they should cash in their euros stash ahead of the Brexit result today. As a finance academic and a former currency market participant I think the best answer here is to ask
“what do the currency markets think ?”
More specifically, what is the expected impact of Brexit on the chunnel rate (the EUR/GBP currency pair) according to the FX option markets. We can use expectation theory to provide us with an estimate of the impact based on the probability of Brexit and the expected % change in the chunnel rate for either scenario. Mathematically:
Bloomberg has some excellent estimates to fill in the blanks on the right-hand side of the above equation. Specifically, they have used the EUR/GBP and USD/GBP FX options markets to produced both an implied probability of Brexit and its % impact on EUR/GBP rate. Table 1 shows these estimates averaged for the last 30 days1. I have also included the implied probabilities of Brexit from a number of other sources as a comparison.
|Source of Probabilities||Probability Brexit||Probability Remain||Expected Move in EUR/GBP | Brexit||Expected Move in EUR/GBP | Remain||Expect Impact of Brexit|
|BBG FX Options||20.29||79.71||6.82||-6.82||-4.16|
From the last column in Table 1 in all scenarios the expected impact is negative for my mate’s stash of Euro. In conclusion, cash in the stash before they are devalued!
UPDATE POST BREXIT:
Clearly my symmetrical assumption on Brexit impact was misguided and if I had considered my other post, this lack of symmetry would be obvious. If i had assumed a no change assumption for a remain vote the calculations would have looked much different:
|Source of Probabilities||Probability Brexit (%)||Probability Remain (%)||Expected Move in EUR/GBP | Brexit||Expected Move in EUR/GBP | Remain||Expect Impact of Brexit|
|BBG FX Options||19.49||80.51||6.82||0.00||1.33|
- Figure 1 and Figure 2 are time series graphs of underlying indices that these averages are based on:
Figure 1: BRXBEUR Index (Bloomberg Expected Move in EUR/GBP in the Event of BREXIT)
Figure 2: BRXBLEAV Index (Bloomberg Probability of BREXIT from the FX Options Markets)