FOREIGN EXCHANGE OPTIONS UNDER STOCHASTIC VOLATILITY AND STOCHASTIC INTEREST RATES

Rehez Ahlip ()
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Rehez Ahlip: School of Computing and Mathematics, University of Western Sydney, Locked Bag 1797, Penrith South DC, NSW 1797, Australia

International Journal of Theoretical and Applied Finance (IJTAF), 2008, vol. 11, issue 03, 277-294

Abstract: In this paper, we present a stochastic volatility model with stochastic interest rates in a Foreign Exchange (FX) setting. The instantaneous volatility follows a mean-reverting Ornstein–Uhlenbeck process and is correlated with the exchange rate. The domestic and foreign interest rates are modeled by mean-reverting Ornstein–Uhlenbeck processes. The main result is an analytic formula for the price of a European call on the exchange rate. It is derived using martingale methods in arbitrage pricing of contingent claims and Fourier inversion techniques.

Keywords: Foreign exchange options; Ornstein–Uhlenbeck process; stochastic volatility (search for similar items in EconPapers)
Date: 2008
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Citations: View citations in EconPapers (10)

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DOI: 10.1142/S0219024908004804

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