Pricing Foreign Equity Options with Stochastic Correlation and Volatility

Jun Ma
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Jun Ma: Temasek Laboratories, National University of Singapore

Annals of Economics and Finance, 2009, vol. 10, issue 2, 303-327

Abstract: A new class of foreign equity option pricing model is suggested that not only allows for the volatility but also for the correlation coefficient to vary stochastically over time. A modified Jacobi process is proposed to evaluate risk premium of the stochastic correlation, and a partial differential equation to price the correlation risk for the foreign equity has been set up, whose solution has been compared with the one with constant correlation. Since taking into account the stochastic volatility gives rise to more dimensions that produce more difficulty in numerical implementation of partial differential equation and Monte carlo, we figure out a series solution for pricing options under the correlation risk.

Keywords: Exotic option; Option pricing; Correlation risk; Portfolio; Random walk (search for similar items in EconPapers)
JEL-codes: D81 E43 G10 G12 G13 (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (13)

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