A continuous-time model for valuing foreign exchange options

DOI10.1155/2013/635746MaRDI QIDQ2318921zbMATH OpenOpenAlexWikidataFDO

Authors James J. Kung

Publication date 16 August 2019

Published in Abstract and Applied Analysis (Search for Journal in Brave)

Copyright license Creative Commons Attribution 3.0 Unported

Full work available at URL https://doi.org/10.1155/2013/635746

zbMATH Keywords

continuous-time modelexchange options valuation

Mathematics Subject Classification ID

PDEs in connection with game theory, economics, social and behavioral sciences (35Q91) Applications of stochastic analysis (to PDEs, etc.) (60H30) Derivative securities (option pricing, hedging, etc.) (91G20)

Review text

Summary: This paper makes use of stochastic calculus to develop a continuous-time model for valuing European options on foreign exchange (FX) when both domestic and foreign spot rates follow a generalized Wiener process. Using the Dollar/Euro exchange rate as input for parameter estimation and employing our FX option model as a yardstick, we find that the traditional Garman-Kohlhagen FX option model, which assumes constant spot rates, values incorrectly calls and puts for different values of the ratio of exchange rate to exercise price. Specifically, it undervalues calls when the ratio is between 0.70 and 1.08, and it overvalues calls when the ratio is between 1.18 and 1.30, whereas it overvalues puts when the ratio is between 0.70 and 0.82, and it undervalues puts when the ratio is between 0.86 and 1.30.

Recommendations

• FOREIGN EXCHANGE OPTIONS UNDER STOCHASTIC VOLATILITY AND STOCHASTIC INTEREST RATES
• Pricing foreign currency options with stochastic volatility
• Computational aspects of pricing foreign exchange options with stochastic volatility and stochastic interest rates
• A non random walk theory of exchange rate dynamics with applications to option pricing
• Pricing of foreign exchange options under the Heston stochastic volatility model and CIR interest rates

Cites work

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Cited in

(2)

• Valuing foreign exchange rate derivatives with a bounded exchange process
• A non random walk theory of exchange rate dynamics with applications to option pricing

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