Currency Derivatives under a Minimal Market Model with Random Scaling

David Heath and Eckhard Platen ()

No 154, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

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)
JEL-codes: D52 G10 G13 (search for similar items in EconPapers)
Pages: 22 pages
Date: 2005-03-01
New Economics Papers: this item is included in nep-fin
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Citations: View citations in EconPapers (3)

Published as: Heath, D. and Platen, E., 2005, "Currency Derivatives under a Minimal Market Model with Random Scaling", International Journal of Theoretical and Applied Finance, 8(8), 1157-1177.

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https://www.uts.edu.au/sites/default/files/qfr-archive-02/QFR-rp154.pdf (application/pdf)

Related works:
Journal Article: CURRENCY DERIVATIVES UNDER A MINIMAL MARKET MODEL WITH RANDOM SCALING (2005)
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