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Pricing of European currency options considering the dynamic information costs

Author

Listed:
  • Dammak, Wael
  • Hamad, Salah Ben
  • de Peretti, Christian
  • Eleuch, Hichem

Abstract

Dynamic costs arising from the variable impact of information on asset pricing present a challenge for accurate European currency option pricing. The Garman and Kohlhagen model, though influential in the literature, does not adequately account for these costs. This study extends the model by integrating an intensity function into the interest rates to measure dynamic information costs. Inspired by the Beer–Lambert law, the function is applied to a decade-long dataset of daily futures continuous calls on the EUR/USD pair from September 21, 2012, to September 23, 2022. The augmented model reduces pricing errors and manages implied volatility better than the 1983 model, consistent across different categories of maturity and moneyness. Our findings emphasize the need to consider dynamic information costs in asset pricing, demonstrating that their inclusion can significantly enhance the accuracy and reliability of currency option pricing.

Suggested Citation

  • Dammak, Wael & Hamad, Salah Ben & de Peretti, Christian & Eleuch, Hichem, 2023. "Pricing of European currency options considering the dynamic information costs," Global Finance Journal, Elsevier, vol. 58(C).
    • Handle: RePEc:eee:glofin:v:58:y:2023:i:c:s1044028323000923
    DOI: 10.1016/j.gfj.2023.100897
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    More about this item

    Keywords

    Currency options; Garman and Kohlhagen's model; Dynamic information costs; Derivatives; Market imperfections; Beer–Lambert law;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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