REHEZ AHLIP () (School of Computing and Mathematics, University of Western Sydney, Locked Bag 1797, Penrith South DC, NSW 1797, Australia)
Abstract
In this paper, we present a stochastic volatility model with stochastic interest rates in a Foreign Exchange (FX) setting. The instantaneous volatility follows a mean-reverting OrnsteinâUhlenbeck process and is correlated with the exchange rate. The domestic and foreign interest rates are modeled by mean-reverting OrnsteinâUhlenbeck processes. The main result is an analytic formula for the price of a European call on the exchange rate. It is derived using martingale methods in arbitrage pricing of contingent claims and Fourier inversion techniques.
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