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An Empirical Examination of the Variance-Gamma Model for Foreign Currency Options

Author

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  • Elton A. Daal

    (University of New Orleans)

  • Dilip B. Madan

    (University of Maryland)

Abstract

We apply the variance-gamma (VG) option-pricing model to currency options. The model is a pure infinite-activity jump model. We examine whether and to what extent this new model can improve the pricing quality for currency options over the existing modified Black-Scholes model and the Merton jump-diffusion (JD) model. We find that the VG model yields better out-of-sample pricing performance than the modified Black-Scholes model or the JD model. In addition, a cross-entropy analysis shows that the VG model is more consistent with the general criterion of utility maximization and optimal portfolio selection.

Suggested Citation

  • Elton A. Daal & Dilip B. Madan, 2005. "An Empirical Examination of the Variance-Gamma Model for Foreign Currency Options," The Journal of Business, University of Chicago Press, vol. 78(6), pages 2121-2152, November.
    • Handle: RePEc:ucp:jnlbus:v:78:y:2005:i:6:p:2121-2152
    DOI: 10.1086/497039
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