CURRENCY DERIVATIVES UNDER A MINIMAL MARKET MODEL WITH RANDOM SCALING

David Heath and Eckhard Platen ()
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David Heath: University of Technology Sydney, School of Finance & Economics and Department of Mathematical Sciences, PO Box 123, Broadway, NSW, 2007, Australia

International Journal of Theoretical and Applied Finance (IJTAF), 2005, vol. 08, issue 08, 1157-1177

Abstract: This paper uses an alternative, parsimonious stochastic volatility model to describe the dynamics of a currency market for the pricing and hedging of derivatives. Time transformed squared Bessel processes are the basic driving factors of the minimal market model. The time transformation is characterized by a random scaling, which provides for realistic exchange rate dynamics. The pricing of standard European options is studied. In particular, it is shown that the model produces implied volatility surfaces that are typically observed in real markets.

Keywords: Currency derivatives; stochastic volatility; random scaling; minimal market model (search for similar items in EconPapers)
Date: 2005
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Citations: View citations in EconPapers (7)

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Working Paper: Currency Derivatives under a Minimal Market Model with Random Scaling (2005)
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DOI: 10.1142/S0219024905003360

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