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FOREWORD B Y STEVE N N.S . CHEUN G Reading thi s boo k remind s m e of that gla d mornin g thirt y year s ago , when a coteri e o f youn g lion s unde r Arme n Alchia n an d Jac k Hirshleife r was har d a t work , layin g th e foundation s o f finance. Bil l Sharp e invente d CAPM (fo r whic h h e wa s awarde d th e Nobe l Priz e th e yea r befor e last) , while I ca n stil l remembe r th e thril l o f discoverin g th e firs t applicatio n o f decision making under uncertainty to contracts, to solve the classic problem of sharecropping . I have alway s believed financ e i s a branch o f economics. No w that ou r new Schoo l o f Economic s i s lookin g t o develo p teachin g an d researc h i n finance, I a m delighte d Michae l Cheun g an d Davi d Yeun g hav e com e u p with a new and interestin g piec e of work in the field. Thei r boo k originate d in a problem Milton Friedman and I have been mulling over for years, of how "virtual" transactions in foreign exchange futures affec t spo t prices. Cheun g and Yeun g propos e t o synthesis e internationa l monetar y theor y wit h th e Samuelson-Black-Scholes insigh t that asse t prices follow diffusio n processes , and obtai n a system of stochastic differentia l equation s t o model exchang e rate dynamic s under th e influence of purchasing power parity. Thi s analysi s suggests a way in which my problem may b e approached: contract s bough t and sol d i n th e future s marke t affec t individua l estimate s o f a currency' s purchasing powe r parity . The author s presen t a n exac t formul a t o pric e option s o n a currency , which incorporate s th e influenc e o f it s purchasin g powe r parity . Becaus e they obtain a closed form expression for th e exchange rate's transition den sity function , thi s resul t i s operational. Ronal d Coas e an d I hav e spen t a goodly par t o f our tim e teachin g tha t goo d economic s mus t b e operationa l economics, s o I awai t wit h interes t practica l application s o f Cheun g an d Yeung's mode l in th e financial markets . ...

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