Pricing currency options under double exponential jump diffusion in a Markov-modulated HJM economy

Pricing currency options under double exponential jump diffusion in a Markov-modulated HJM economy Extending the framework of Amin and Jarrow (J Int Money Financ 10:310–329, 1991) and Bo et al. (Insur Math Econ 46:461–469, 2010), this study provides a theoretical exploration of currency options pricing under the presence of interest-rate regime shifts and exchange-rate asymmetric jumps. Evidence of interest-rate regime shifts inferred from UK and US zero coupon bond yields provides support for the regime-switching specifications which we reflect upon the domestic and foreign forward rates. Results of statistical tests conducted on JPY/USD and EUR/USD FX rates provide further support the rationale behind using a double exponential jump diffusion process within a Markov modulated Heath–Jarrow–Morton economy. Our numerical results suggest that, the pricing performance of our model is closely comparable to the Bo-Wang-Yang model for at-the-money options, yet yields improvements in percentage root mean errors for in-the-money options. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

Pricing currency options under double exponential jump diffusion in a Markov-modulated HJM economy

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Publisher
Springer Journals
Copyright
Copyright © 2014 by Springer Science+Business Media New York
Subject
Finance; Corporate Finance; Accounting/Auditing; Econometrics; Operation Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1007/s11156-014-0478-9
Publisher site
See Article on Publisher Site

Abstract

Extending the framework of Amin and Jarrow (J Int Money Financ 10:310–329, 1991) and Bo et al. (Insur Math Econ 46:461–469, 2010), this study provides a theoretical exploration of currency options pricing under the presence of interest-rate regime shifts and exchange-rate asymmetric jumps. Evidence of interest-rate regime shifts inferred from UK and US zero coupon bond yields provides support for the regime-switching specifications which we reflect upon the domestic and foreign forward rates. Results of statistical tests conducted on JPY/USD and EUR/USD FX rates provide further support the rationale behind using a double exponential jump diffusion process within a Markov modulated Heath–Jarrow–Morton economy. Our numerical results suggest that, the pricing performance of our model is closely comparable to the Bo-Wang-Yang model for at-the-money options, yet yields improvements in percentage root mean errors for in-the-money options.

Journal

Review of Quantitative Finance and AccountingSpringer Journals

Published: Sep 10, 2014

References

  • On Jumps in common stock prices and their impact on call option pricing
    Ball, CA; Torous, WN
  • On the nonlinear specifications of short-term interest rate behavior: evidence from euro-currency markets
    Chiang, TC; Chiang, JJ
  • A model for stock market returns: non-Gaussian fluctuations and financial factors
    Craven, BD; Islam, MNS
  • Evidence of feedback trading with Markov switching regimes
    Dean, WG; Faff, RW
  • Option pricing and Esscher transform under regime switching
    Elliott, RJ; Chan, L; Siu, TK

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