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The Pricing of Call and Put Options on Foreign Exchange


  • Orlin J. Grabbe


This paper derives exact pricing equations for American and European puts and calls on foreign exchange and discusses hedging strategy. Because every call option on foreign currency is simultaneously a put option on the domestic currency, an equivalence relation exists that allows the immediate derivation of put equations from the corresponding call formulas. The call and put pricing formulas are unlike the Black-Scholes equations for stock options in that there are two relevant interest rates, interest rates are stochastic, and boundary constraints differ. In addition, both American call and put options have values larger than their European counterparts.

Suggested Citation

  • Orlin J. Grabbe, "undated". "The Pricing of Call and Put Options on Foreign Exchange," Rodney L. White Center for Financial Research Working Papers 6-83, Wharton School Rodney L. White Center for Financial Research.
  • Handle: RePEc:fth:pennfi:6-83

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    References listed on IDEAS

    1. Harrison, J Michael & Pitbladdo, Richard & Schaefer, Stephen M, 1984. "Continuous Price Processes in Frictionless Markets Have Infinite Variation," The Journal of Business, University of Chicago Press, vol. 57(3), pages 353-365, July.
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    3. Grossman, S J & Melino, Angelo & Shiller, Robert J, 1987. "Estimating the Continuous-Time Consumption-Based Asset-Pricing Model," Journal of Business & Economic Statistics, American Statistical Association, vol. 5(3), pages 315-327, July.
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    7. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    8. Sims, Christopher A, 1971. "Discrete Approximations to Continuous Time Distributed Lags in Econometrics," Econometrica, Econometric Society, vol. 39(3), pages 545-563, May.
    9. Marsh, Terry A & Rosenfeld, Eric R, 1983. " Stochastic Processes for Interest Rates and Equilibrium Bond Prices," Journal of Finance, American Finance Association, vol. 38(2), pages 635-646, May.
    10. Phillips, P C B, 1972. "The Structural Estimation of a Stochastic Differential Equation System," Econometrica, Econometric Society, vol. 40(6), pages 1021-1041, November.
    11. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-233, March.
    12. Ball, Clifford A & Torous, Walter N, 1985. " On Jumps in Common Stock Prices and Their Impact on Call Option Pricing," Journal of Finance, American Finance Association, vol. 40(1), pages 155-173, March.
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