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Empirical performance of alternative pricing models of currency options

✍ Scribed by Sarwar, Ghulam; Krehbiel, Timothy

Publisher
John Wiley and Sons
Year
2000
Tongue
English
Weight
244 KB
Volume
20
Category
Article
ISSN
0270-7314

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✦ Synopsis

This article examines the out-of-sample pricing performance and biases of the Heston's stochastic volatility and modified Black-Scholes option pricing models in valuing European currency call options written on British pound. The modified Black-Scholes model with daily-revised implied volatilities performs as well as the stochastic volatility model in the aggregate sample. Both models provide close and similar correspondence to actual prices for options trading near-or at-the-money. The prices generated from the stochastic volatility model are subject to fewer and weaker aggregate pricing biases than are the prices from the modified Black-Scholes model. Thus, the stochastic volatility model may provide improved estimates of the measures of option price sensitivities to key option parameters that may lead to more effective hedging and speculative strategies using currency options.

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