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Pricing currency options in the Heston/CIR double exponential jump-diffusion model

Author

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  • Rehez Ahlip

    (School of Computing Engineering and Mathematics, Western Sydney University, Penrith South, NSW 1797, Australia)

  • Laurence A. F. Park

    (School of Computing Engineering and Mathematics, Western Sydney University, Penrith South, NSW 1797, Australia)

  • Ante Prodan

    (School of Computing Engineering and Mathematics, Western Sydney University, Penrith South, NSW 1797, Australia)

Abstract

We examine currency options in the double exponential jump-diffusion version of the Heston stochastic volatility model for the exchange rate. We assume, in addition, that the domestic and foreign stochastic interest rates are governed by the CIR dynamics. The instantaneous volatility is correlated with the dynamics of the exchange rate return, whereas the domestic and foreign short-term rates are assumed to be independent of the dynamics of the exchange rate and its volatility. The main result furnishes a semi-analytical formula for the price of the European currency call option in the hybrid foreign exchange/interest rates model.

Suggested Citation

  • Rehez Ahlip & Laurence A. F. Park & Ante Prodan, 2017. "Pricing currency options in the Heston/CIR double exponential jump-diffusion model," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 4(01), pages 1-30, March.
    • Handle: RePEc:wsi:ijfexx:v:04:y:2017:i:01:n:s242478631750013x
    DOI: 10.1142/S242478631750013X
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    2. Fazlollah Soleymani & Andrey Itkin, 2019. "Pricing foreign exchange options under stochastic volatility and interest rates using an RBF--FD method," Papers 1903.00937, arXiv.org.
    3. Matthias Muck, 2022. "Arbitrage-free smile construction on FX option markets using Garman-Kohlhagen deltas and implied volatilities," Review of Derivatives Research, Springer, vol. 25(3), pages 293-314, October.

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