Pricing of European currency options considering the dynamic information costs

Wael Dammak, Salah Ben Hamad, Christian de Peretti and Hichem Eleuch

Global Finance Journal, 2023, vol. 58, issue C

Abstract: Dynamic costs arising from the variable impact of information on asset pricing present a challenge for accurate European currency option pricing. The Garman and Kohlhagen model, though influential in the literature, does not adequately account for these costs. This study extends the model by integrating an intensity function into the interest rates to measure dynamic information costs. Inspired by the Beer–Lambert law, the function is applied to a decade-long dataset of daily futures continuous calls on the EUR/USD pair from September 21, 2012, to September 23, 2022. The augmented model reduces pricing errors and manages implied volatility better than the 1983 model, consistent across different categories of maturity and moneyness. Our findings emphasize the need to consider dynamic information costs in asset pricing, demonstrating that their inclusion can significantly enhance the accuracy and reliability of currency option pricing.

Keywords: Currency options; Garman and Kohlhagen's model; Dynamic information costs; Derivatives; Market imperfections; Beer–Lambert law (search for similar items in EconPapers)
JEL-codes: C61 F47 G13 G14 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:glofin:v:58:y:2023:i:c:s1044028323000923

DOI: 10.1016/j.gfj.2023.100897

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