Please use this identifier to cite or link to this item: http://hdl.handle.net/1959.14/136064
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- Title
- Pricing currency options under two-factor Markov-modulated stochastic volatility models
- Related
- Insurance, mathematics and economics, Vol. 43, No. 3, (2008), p.295-302
- DOI
- 10.1016/j.insmatheco.2008.05.002
- Publisher
- Elsevier BV
- Date
- 2008
- FoR/RFCD Code(s)
-
010400 Statistics
140200 Applied Economics
- Author/Creator
- Siu, Tak Kuen
- Author/Creator
- Yang, Hailiang
- Author/Creator
- Lau, John W
- Description
- This article investigates the valuation of currency options when the dynamic of the spot Foreign Exchange (FX) rate is governed by a two-factor Markov-modulated stochastic volatility model, with the first stochastic volatility component driven by a lognormal diffusion process and the second independent stochastic volatility component driven by a continuous-time finite-state Markov chain model. The states of the Markov chain can be interpreted as the states of an economy. We employ the regime-switching Esscher transform to determine a martingale pricing measure for valuing currency options under the incomplete market setting. We consider the valuation of the European-style and American-style currency options. In the case of American options, we provide a decomposition result for the American option price into the sum of its European counterpart and the early exercise premium. Numerical results are included.
- Description
- 8 page(s)
- Subject Keyword
- 010400 Statistics
- Subject Keyword
- 140200 Applied Economics
- Subject Keyword
- currency options
- Subject Keyword
- two-factor stochastic volatility
- Subject Keyword
- regime switching
- Subject Keyword
- Esscher transform
- Subject Keyword
- decomposition
- Resource Type
- journal article
- Organisation
- Macquarie University. Dept. of Applied Finance and Actuarial Studies
- Identifier
- http://hdl.handle.net/1959.14/136064
- Identifier
- ISSN:0167-6687
- Identifier
- mq-rm-2009000231
- Language
- eng
- Reviewed
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