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

  • Elton A. Daal

    (University of New Orleans)

  • Dilip B. Madan

    (University of Maryland)

Registered author(s):

    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.

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    File URL: http://www.journals.uchicago.edu/cgi-bin/resolve?JB780603
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    Article provided by University of Chicago Press in its journal Journal of Business.

    Volume (Year): 78 (2005)
    Issue (Month): 6 (November)
    Pages: 2121-2152

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    Handle: RePEc:ucp:jnlbus:v:78:y:2005:i:6:p:2121-2152
    Contact details of provider: Web page: http://www.journals.uchicago.edu/JB/

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