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Equilibrium pricing of currency options under a discontinuous model in a two-country economy

Author

Listed:
  • Xing Yu

    (School of Finance, Nanjing Audit University, Nanjing 211815, PR China)

  • Yang Xiaoping

    (School of Science, Nanjing University of Science and Technology, Nanjing 210094, PR China)

Abstract

(Bakshi, G., and Z. Chen. 1997. “Equilibrium Valuation of Foreign Exchange Claims.” Journal of Finance 52: 799–826) studied equilibrium valuation for foreign exchange claims in the setting of the two-country Lucas-type economy. In Bakshi and Chen (1997), they assumed the money supplies follow two-factor stochastic volatility processes. Based on their model, we add two independent Poisson-type jumps, respectively into the process of money supply in each country. By solving a partial integro-differential equation (PIDE) for currency options, we get closed-form solutions of call currency option prices. Our model is a generalization of Bakshi and Chen (1997), and can contain a class of stochastic-volatility jump-diffusion (SVJD) models as special cases.

Suggested Citation

  • Xing Yu & Yang Xiaoping, 2016. "Equilibrium pricing of currency options under a discontinuous model in a two-country economy," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 20(2), pages 185-198, April.
    • Handle: RePEc:bpj:sndecm:v:20:y:2016:i:2:p:185-198:n:5
    DOI: 10.1515/snde-2015-0001
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    References listed on IDEAS

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    1. Heston, Steven L, 1993. "A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options," The Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 327-343.
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    4. Kaushik I. Amin & Robert A. Jarrow, 2008. "Pricing foreign currency options under stochastic interest rates," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 14, pages 307-326, World Scientific Publishing Co. Pte. Ltd..
    5. Ciprian Necula, 2008. "Asset Pricing in a Two-Country Discontinuous General Equilibrium Model," Advances in Economic and Financial Research - DOFIN Working Paper Series 24, Bucharest University of Economics, Center for Advanced Research in Finance and Banking - CARFIB.
    6. 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.
    7. Cao, Melanie, 2001. "Systematic jump risks in a small open economy: simultaneous equilibrium valuation of options on the market portfolio and the exchange rate," Journal of International Money and Finance, Elsevier, vol. 20(2), pages 191-218, April.
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