Pricing Currency Options with a Market Model of Interest Rates under Jump-Diffusion Stochastic Volatility Processes of Spot Exchange Rates

Akihiko Takahashi, , Kota Takehara and Akira Yamazaki
Additional contact information
Akihiko Takahashi: Faculty of Economics, University of Tokyo
, Kota Takehara: Graduate School of Economics, University of Tokyo
Akira Yamazaki: Mizuho-DL Financial Technology Co., Ltd.

No CIRJE-F-451, CIRJE F-Series from CIRJE, Faculty of Economics, University of Tokyo

Abstract: This paper proposes a pricing method of currency options with a market model of interest rates. Using a simple approximation and a Fourier transform method, we derive a formula of the option pricing under jump-diffusion stochastic volatility processes of spot exchange rates. As an application, we apply the formula to the calibration of volatility smiles in the JPY/USD currency option market. Moreover, using the approximate prices as a control variate, we achieve substantial variance reduction in Monte Carlo simulation.

Pages: 25pages
Date: 2006-12
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Citations: View citations in EconPapers (7)

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