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Accounting for the impact of higher order moments in foreign equity option pricing model

  • Xu, Weidong
  • Wu, Chongfeng
  • Li, Hongyi

This paper investigates the pricing of foreign equity option whose value depends on foreign equity prices and exchange rate. We assume that the underlying asset returns of foreign equity option is not a Brownian motion, and use the Gram-Charlier series expansion to augment a normal density with two additional terms to capture the effects of skewness and kurtosis. The empirical study shows that the higher order moments (skewness and kurtosis) clearly affect the estimated prices of foreign equity options. This approach enables us to capture more accurately the foreign equity option prices.

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Article provided by Elsevier in its journal Economic Modelling.

Volume (Year): 28 (2011)
Issue (Month): 4 (July)
Pages: 1726-1729

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Handle: RePEc:eee:ecmode:v:28:y:2011:i:4:p:1726-1729
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30411

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  1. S. G. Kou, 2002. "A Jump-Diffusion Model for Option Pricing," Management Science, INFORMS, vol. 48(8), pages 1086-1101, August.
  2. Xu, Weidong & Wu, Chongfeng & Li, Hongyi, 2011. "Foreign equity option pricing under stochastic volatility model with double jumps," Economic Modelling, Elsevier, vol. 28(4), pages 1857-1863, July.
  3. Peter Carr & Liuren Wu, 2004. "Stochastic Skew in Currency Options," Finance 0409014, EconWPA.
  4. Wei, J.Z. & Duan, J.C., 1999. "Pricing Foreign Currency and Cross-Currency Options Under GARCH," Rotman School of Management - Finance 99-01, Rotman School of Management, University of Toronto.
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  7. Longstaff, Francis A, 1995. "Option Pricing and the Martingale Restriction," Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 1091-1124.
  8. T. S. Ho & Richard C. Stapleton & Marti G. Subrahmanyam, 1995. "Correlation risk, cross-market derivative products and portfolio performance," European Financial Management, European Financial Management Association, vol. 1(2), pages 105-124.
  9. Bakshi, Gurdip & Cao, Charles & Chen, Zhiwu, 1997. " Empirical Performance of Alternative Option Pricing Models," Journal of Finance, American Finance Association, vol. 52(5), pages 2003-49, December.
  10. Johnson, Timothy C, 2002. "Volatility, Momentum, and Time-Varying Skewness in Foreign Exchange Returns," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(3), pages 390-411, July.
  11. Johnson, Gordon & Schneeweis, Thomas, 1994. "Jump-Diffusion Processes in the Foreign Exchange Markets and the Release of Macroeconomic News," Computational Economics, Society for Computational Economics, vol. 7(4), pages 309-29.
  12. Frank Milne & Dilip Madan, 1994. "Contingent Claims Valued And Hedged By Pricing And Investing In A Basis," Working Papers 1158, Queen's University, Department of Economics.
  13. Bates, David S, 1996. "Jumps and Stochastic Volatility: Exchange Rate Processes Implicit in Deutsche Mark Options," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 69-107.
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  15. Bates, David S., 2000. "Post-'87 crash fears in the S&P 500 futures option market," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 181-238.
  16. Jarrow, Robert & Rudd, Andrew, 1982. "Approximate option valuation for arbitrary stochastic processes," Journal of Financial Economics, Elsevier, vol. 10(3), pages 347-369, November.
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