Akihiko Takahashi (Faculty of Economics, University of Tokyo) Kohta Takehara (Graduate School of Economics, University of Tokyo)
Abstract
This chapter presents a basic of the methodology so-called an asymptotic expansion approach, and applies this method to approximation of prices of currency options with a libor market model of interest rates and stochastic volatility models of spot exchange rates. The scheme enables us to derive closed-form approximation formulas for pricing currency options even with high flexibility of the underlying model; we do not model a foreign exchange rate's variance such as in Heston [27], but its volatility that follows a general time-inhomogeneous Markovian process. Further, the correlations among all the factors such as domestic and foreign interest rates, a spot foreign exchange rate and its volatility, are allowed. At the end of this chapter some numerical examples are provided and the pricing formula is applied to the calibration of volatility surfaces in the JPY/USD option market.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
Publisher Info
Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number
CIRJE-F-654.