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A class of nonlinear stochastic volatility models and its implications for pricing currency options

Listed author(s):
  • Yu, Jun
  • Yang, Zhenlin
  • Zhang, Xibin

This paper proposes a class of stochastic volatility (SV) models which offers an alternative to the one introduced in Andersen (1994). The class encompasses all standard SV models that have appeared in the literature, including the well known lognormal model, and allows us to empirically test all standard specifications in a convenient way. We develop a likelihood-based technique for analyzing the class. Daily dollar/pound exchange rate data reject all the standard models and suggest evidence of nonlinear SV. An efficient algorithm is proposed to study the implications of this nonlinear SV on pricing currency options and it is found that the lognormal model overprices options.

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File URL: http://www.sciencedirect.com/science/article/pii/S0167-9473(06)00285-4
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Article provided by Elsevier in its journal Computational Statistics & Data Analysis.

Volume (Year): 51 (2006)
Issue (Month): 4 (December)
Pages: 2218-2231

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Handle: RePEc:eee:csdana:v:51:y:2006:i:4:p:2218-2231
Contact details of provider: Web page: http://www.elsevier.com/locate/csda

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