A Class of Nonlinear Stochastic Volatility Models and Its Implications on Pricing Currency Options

Jun Yu, Zhenlin Yang and Xibin Zhang ()

No 17/02, Monash Econometrics and Business Statistics Working Papers from Monash University, Department of Econometrics and Business Statistics

Abstract: This paper proposes a class of stochastic volatility (SV) models which offers an alternative to the one introduced in Andersen (1994). The class encompasses all standard SV models that have appeared in the literature, including the well known lognormal model, and allows us to empirically test all standard specifications in a convenient way. We develop a likelihood-based technique for analyzing the class. Daily dollar/pound exchange rate data reject all the standard models and suggest evidence of nonlinear SV. An efficient algorithm is proposed to study the implications of this nonlinear SV on pricing currency options and it is found that the lognormal model overprices options.

Keywords: Box-Cox transformations; Stochastic volatility; MCMC; Exchange rate volatility; Option pricing. (search for similar items in EconPapers)
JEL-codes: C22 C52 G12 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2002-11
New Economics Papers: this item is included in nep-cfn, nep-ecm, nep-ets, nep-fmk, nep-ifn and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Related works:
Journal Article: A class of nonlinear stochastic volatility models and its implications for pricing currency options (2006)
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