Fourier Transform Method with an Asymptotic Expansion Approach: an Application to Currency Options

Akihiko Takahashi and Kohta Takehara
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Akihiko Takahashi: Faculty of Economics, University of Tokyo
Kohta Takehara: Graduate School of Economics, University of Tokyo

No CIRJE-F-538, CIRJE F-Series from CIRJE, Faculty of Economics, University of Tokyo

Abstract: This paper develops a Fourier transform method with an asymptotic expansion approach for option pricing. The method is applied to European currency options with a libor market model of interest rates and jump-diffusion stochastic volatility models of spot exchange rates. In particular, we derive closed-form approximation formulas of the characteristic functions of log-prices of the underlying assets and the prices of currency options based on a third order asymptotic expansion scheme; we use a jump- diffusion model with a mean-reverting stochastic variance process such as in Heston [1993] / Bates [1996] and log-normal market models for domestic and foreign interest rates. Finally, the validity of our method is confirmed through numerical examples.

Pages: 28 pages
Date: 2008-01
New Economics Papers: this item is included in nep-ifn
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Citations: View citations in EconPapers (12)

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