A Continuous-Time Model for Valuing Foreign Exchange Options
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...
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| Format: | Article |
| Language: | English |
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Wiley
2013-01-01
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| Series: | Abstract and Applied Analysis |
| Online Access: | http://dx.doi.org/10.1155/2013/635746 |
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| _version_ | 1832548802622390272 |
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| author | James J. Kung |
| author_facet | James J. Kung |
| author_sort | James J. Kung |
| collection | DOAJ |
| description | 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. |
| format | Article |
| id | doaj-art-24601edfca91431a8515df4c098f1f1c |
| institution | Kabale University |
| issn | 1085-3375 1687-0409 |
| language | English |
| publishDate | 2013-01-01 |
| publisher | Wiley |
| record_format | Article |
| series | Abstract and Applied Analysis |
| spelling | doaj-art-24601edfca91431a8515df4c098f1f1c2025-02-03T06:12:56ZengWileyAbstract and Applied Analysis1085-33751687-04092013-01-01201310.1155/2013/635746635746A Continuous-Time Model for Valuing Foreign Exchange OptionsJames J. Kung0School of Management, Ming Chuan University, Taipei 111, TaiwanThis 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.http://dx.doi.org/10.1155/2013/635746 |
| spellingShingle | James J. Kung A Continuous-Time Model for Valuing Foreign Exchange Options Abstract and Applied Analysis |
| title | A Continuous-Time Model for Valuing Foreign Exchange Options |
| title_full | A Continuous-Time Model for Valuing Foreign Exchange Options |
| title_fullStr | A Continuous-Time Model for Valuing Foreign Exchange Options |
| title_full_unstemmed | A Continuous-Time Model for Valuing Foreign Exchange Options |
| title_short | A Continuous-Time Model for Valuing Foreign Exchange Options |
| title_sort | continuous time model for valuing foreign exchange options |
| url | http://dx.doi.org/10.1155/2013/635746 |
| work_keys_str_mv | AT jamesjkung acontinuoustimemodelforvaluingforeignexchangeoptions AT jamesjkung continuoustimemodelforvaluingforeignexchangeoptions |