Stochastic interest rate and stochastic volatility models of currency futures options.
Item
-
Title
-
Stochastic interest rate and stochastic volatility models of currency futures options.
-
Identifier
-
AAI9405536
-
identifier
-
9405536
-
Creator
-
Jithendranathan, Thadavillil.
-
Contributor
-
Adviser: Kishore Tandon
-
Date
-
1993
-
Language
-
English
-
Publisher
-
City University of New York.
-
Subject
-
Economics, Finance
-
Abstract
-
Currency futures options are used by multinational corporations and investors to hedge the transaction exposure in currency translation. In order to estimate the cost of hedging, investors have to price these futures options; mispricing of the options can lead to substantial losses. In this respect, developing pricing models for these options and empirically testing their pricing accuracy is of prime importance.;While the value of a currency futures option contract depends on the price and volatility of the underlying futures contract, domestic and foreign interest rates, and time to expiration, existing theoretical pricing models are based on the simplifying assumption that the volatility of the underlying asset and the interest rates are non-stochastic. In this study, we derive two different pricing models for options on currency futures which allow domestic and foreign interest rates and the underlying asset variability to be stochastic. Closed form solutions are obtained for European options, and using quadratic approximations American option prices are derived. Pricing efficiency tests of these two models, relative to the constant interest rate and constant underlying asset volatility model, are conducted using transactions data from the International Monetary Market for the following major currencies, i.e. British pound, Deutsche mark, Japanese yen, and Swiss franc. The data contain a total of 6.5 million trades over a period of four years between 1986 and 1989.;Results of the efficiency tests indicate that none of the three models tested is superior to the others in all maturity classes and the at-, in-, and out-of-the money categories. The stochastic interest rate model and stochastic volatility model give better pricing efficiency for some in-the-money options. The constant interest and constant asset volatility model gives better pricing efficiency for at-the-money options. All three models are generally inefficient in pricing out-of-money options.;Pricing efficiency tests are joint tests of model validity and market efficiency. Mispricing by models can be due to one of these two factors, and one needed area of future research will be the use of these models to identify market inefficiency and profit opportunities.
-
Type
-
dissertation
-
Source
-
PQT Legacy CUNY.xlsx
-
degree
-
Ph.D.
