Foreign exchange option pricing under regime switching with asymmetrical jumps

Yu-Min Lian and Jun-Home Chen

Finance Research Letters, 2022, vol. 46, issue PA

Abstract: In this study, we investigate the valuation of foreign exchange (FX) options by identifying a two-factor Markov-modulated stochastic volatility model with double exponential jumps to capture long- and short-term stochastic volatility and asymmetrical jumps in the underlying spot FX rate. Furthermore, the dynamics of domestic/foreign instantaneous forward interest rates are governed by a Markov-modulated Heath-Jarrow-Morton model. The dynamic measure change technique is employed to determine a pricing kernel for deriving the FX option pricing formula. Finally, numerical illustrations are provided and analyzed.

Keywords: Foreign exchange (FX) option; Two-factor Markov-modulated stochastic volatility model with double exponential jumps; Foreign exchange (FX) rate; Markov-modulated Heath-Jarrow-Morton model; Dynamic measure change (search for similar items in EconPapers)
JEL-codes: F31 G12 G13 G15 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:46:y:2022:i:pa:s1544612321003287

DOI: 10.1016/j.frl.2021.102294

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