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Foreign exchange option pricing under regime switching with asymmetrical jumps

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  • Lian, Yu-Min
  • Chen, Jun-Home

Abstract

In this study, we investigate the valuation of foreign exchange (FX) options by identifying a two-factor Markov-modulated stochastic volatility model with double exponential jumps to capture long- and short-term stochastic volatility and asymmetrical jumps in the underlying spot FX rate. Furthermore, the dynamics of domestic/foreign instantaneous forward interest rates are governed by a Markov-modulated Heath-Jarrow-Morton model. The dynamic measure change technique is employed to determine a pricing kernel for deriving the FX option pricing formula. Finally, numerical illustrations are provided and analyzed.

Suggested Citation

  • Lian, Yu-Min & Chen, Jun-Home, 2022. "Foreign exchange option pricing under regime switching with asymmetrical jumps," Finance Research Letters, Elsevier, vol. 46(PA).
    • Handle: RePEc:eee:finlet:v:46:y:2022:i:pa:s1544612321003287
    DOI: 10.1016/j.frl.2021.102294
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    References listed on IDEAS

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    1. Kim, Sung Ik, 2023. "A comparative study of firm value models: Default risk of corporate bonds," Finance Research Letters, Elsevier, vol. 56(C).

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    More about this item

    Keywords

    Foreign exchange (FX) option; Two-factor Markov-modulated stochastic volatility model with double exponential jumps; Foreign exchange (FX) rate; Markov-modulated Heath-Jarrow-Morton model; Dynamic measure change;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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