The Pricing of Foreign Currency Options

Angelo Melino and Stuart M. Turnbull

Canadian Journal of Economics, 1991, vol. 24, issue 2, 251-81

Abstract: This study examines the assumption that the exchange rate follows a log-normal probability distribution and it tests whether different stochastic specifications translate into important differences in implied option prices. The authors investigate a class of processes, which includes the log-normal probability distribution as a limiting case. None of the models perform particularly well. The main problem appears to be that the volatility estimates from actual exchange rate data are significantly smaller than those implied by observed option prices.

Date: 1991
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