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A Class of Nonlinear Stochastic Volatility Models and Its Implications on Pricing Currency Options

Listed author(s):
  • Jun Yu
  • Zhenlin Yang
  • Xibin Zhang

    ()

This paper proposes a class of stochastic volatility (SV) models which offers an alternative to the one introduced in Andersen (1994). The class encompasses all standard SV models that have appeared in the literature, including the well known lognormal model, and allows us to empirically test all standard specifications in a convenient way. We develop a likelihood-based technique for analyzing the class. Daily dollar/pound exchange rate data reject all the standard models and suggest evidence of nonlinear SV. An efficient algorithm is proposed to study the implications of this nonlinear SV on pricing currency options and it is found that the lognormal model overprices options.

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File URL: http://www.buseco.monash.edu.au/ebs/pubs/wpapers/2002/wp17-02.pdf
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Paper provided by Monash University, Department of Econometrics and Business Statistics in its series Monash Econometrics and Business Statistics Working Papers with number 17/02.

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Length: 42 pages
Date of creation: Nov 2002
Handle: RePEc:msh:ebswps:2002-17
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