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Pricing currency options under double exponential jump diffusion in a Markov-modulated HJM economy

Author

Listed:
  • Mi-Hsiu Chiang

    () (National Chengchi University)

  • Chang-Yi Li

    () (Xiamen University)

  • Son-Nan Chen

    () (Shanghai Jiao Tong University)

Abstract

Extending the framework of Amin and Jarrow (J Int Money Financ 10:310–329, 1991) and Bo et al. (Insur Math Econ 46:461–469, 2010), this study provides a theoretical exploration of currency options pricing under the presence of interest-rate regime shifts and exchange-rate asymmetric jumps. Evidence of interest-rate regime shifts inferred from UK and US zero coupon bond yields provides support for the regime-switching specifications which we reflect upon the domestic and foreign forward rates. Results of statistical tests conducted on JPY/USD and EUR/USD FX rates provide further support the rationale behind using a double exponential jump diffusion process within a Markov modulated Heath–Jarrow–Morton economy. Our numerical results suggest that, the pricing performance of our model is closely comparable to the Bo-Wang-Yang model for at-the-money options, yet yields improvements in percentage root mean errors for in-the-money options.

Suggested Citation

  • Mi-Hsiu Chiang & Chang-Yi Li & Son-Nan Chen, 2016. "Pricing currency options under double exponential jump diffusion in a Markov-modulated HJM economy," Review of Quantitative Finance and Accounting, Springer, vol. 46(3), pages 459-482, April.
  • Handle: RePEc:kap:rqfnac:v:46:y:2016:i:3:d:10.1007_s11156-014-0478-9
    DOI: 10.1007/s11156-014-0478-9
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    References listed on IDEAS

    as
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    Cited by:

    1. Rehez Ahlip & Laurence A. F. Park & Ante Prodan, 2017. "Pricing currency options in the Heston/CIR double exponential jump-diffusion model," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 4(01), pages 1-30, March.

    More about this item

    Keywords

    Currency options; Heath–Jarrow–Morton model; Double exponential jump diffusion; Esscher transform; Markov chain;

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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