Pricing Foreign Equity Options with Stochastic Correlation and Volatility
AbstractA new class of foreign equity option pricing model is suggested that not only allows for the volatility but also for the correlation coefficient to vary stochastically over time. A modified Jacobi process is proposed to evaluate risk premium of the stochastic correlation, and a partial differential equation to price the correlation risk for the foreign equity has been set up, whose solution has been compared with the one with constant correlation. Since taking into account the stochastic volatility gives rise to more dimensions that produce more difficulty in numerical implementation of partial differential equation and Monte carlo, we figure out a series solution for pricing options under the correlation risk.
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Bibliographic InfoArticle provided by Society for AEF in its journal Annals of Economics and Finance.
Volume (Year): 10 (2009)
Issue (Month): 2 (November)
Exotic option; Option pricing; Correlation risk; Portfolio; Random walk;
Find related papers by JEL classification:
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
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