An efficient method for pricing foreign currency options

Rongda Chen, Hanxian Zhou, Lean Yu, Chenglu Jin and Shuonan Zhang

Journal of International Financial Markets, Institutions and Money, 2021, vol. 74, issue C

Abstract: We propose an efficient method for pricing foreign currency options given that foreign currency returns have heavy-tailed distributions. In our approach, the heavy tail of the distribution are modeled using Student-t distribution rather than normal distribution, and the parameters of Student-t distribution are estimated using the Method of Moments Estimator (MME). For verification purposes, we perform an empirical analysis based on actual foreign currency option prices. The results show that our foreign currency option pricing model captures more precision in distribution of currency returns and provides a better fit to the data compared to the option pricing models commonly used by currency traders. Our model is also computationally simpler than these models and is easier to apply in academic and practical settings.

Keywords: Foreign currency option; Option pricing model; Heavy-tailed distribution; Student-t distribution (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:intfin:v:74:y:2021:i:c:s1042443121000147

DOI: 10.1016/j.intfin.2021.101295

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