Pricing currency options under double exponential jump diffusion in a Markov-modulated HJM economy

Mi-Hsiu Chiang (), Chang-Yi Li () and Son-Nan Chen ()
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Mi-Hsiu Chiang: National Chengchi University
Chang-Yi Li: Xiamen University
Son-Nan Chen: Shanghai Jiao Tong University

Review of Quantitative Finance and Accounting, 2016, vol. 46, issue 3, No 1, 459-482

Abstract: Abstract Extending the framework of Amin and Jarrow (J Int Money Financ 10:310–329, 1991) and Bo et al. (Insur Math Econ 46:461–469, 2010), this study provides a theoretical exploration of currency options pricing under the presence of interest-rate regime shifts and exchange-rate asymmetric jumps. Evidence of interest-rate regime shifts inferred from UK and US zero coupon bond yields provides support for the regime-switching specifications which we reflect upon the domestic and foreign forward rates. Results of statistical tests conducted on JPY/USD and EUR/USD FX rates provide further support the rationale behind using a double exponential jump diffusion process within a Markov modulated Heath–Jarrow–Morton economy. Our numerical results suggest that, the pricing performance of our model is closely comparable to the Bo-Wang-Yang model for at-the-money options, yet yields improvements in percentage root mean errors for in-the-money options.

Keywords: Currency options; Heath–Jarrow–Morton model; Double exponential jump diffusion; Esscher transform; Markov chain (search for similar items in EconPapers)
JEL-codes: C02 G13 G15 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (2)

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DOI: 10.1007/s11156-014-0478-9

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