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Modeling Volatility in Foreign Currency Option Pricing

Author

Listed:
  • Ariful Hoque

    (Curtin University of Technology, Australia)

  • Felix Chan

    (Curtin University of Technology, Australia)

  • Meher Manzur

    (Curtin University of Technology, Australia)

Abstract

This paper presents a general optimization framework to forecast put and call option prices by exploiting the volatility of the options prices. The approach is flexible in that different objective functions for predicting the underlying volatility can be modified and adapted in the proposed framework. The framework is implemented empirically for four major currencies, including Euro. The forecast performance of this framework is compared with those of the Multiplicative Error Model (MEM) of implied volatility and the GARCH(1,1). The results indicate that the proposed framework is capable of producing reasonable accurate forecasts for put and call prices.

Suggested Citation

  • Ariful Hoque & Felix Chan & Meher Manzur, 2009. "Modeling Volatility in Foreign Currency Option Pricing," Multinational Finance Journal, Multinational Finance Journal, vol. 13(3-4), pages 189-208, September.
    • Handle: RePEc:mfj:journl:v:13:y:2009:i:3-4:p:189-208
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    References listed on IDEAS

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    5. Chiras, Donald P. & Manaster, Steven, 1978. "The information content of option prices and a test of market efficiency," Journal of Financial Economics, Elsevier, vol. 6(2-3), pages 213-234.
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    8. Beckers, Stan, 1981. "Standard deviations implied in option prices as predictors of future stock price variability," Journal of Banking & Finance, Elsevier, vol. 5(3), pages 363-381, September.
    9. Christensen, B. J. & Prabhala, N. R., 1998. "The relation between implied and realized volatility," Journal of Financial Economics, Elsevier, vol. 50(2), pages 125-150, November.
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    Cited by:

    1. Sabiruzzaman, Md. & Monimul Huq, Md. & Beg, Rabiul Alam & Anwar, Sajid, 2010. "Modeling and forecasting trading volume index: GARCH versus TGARCH approach," The Quarterly Review of Economics and Finance, Elsevier, vol. 50(2), pages 141-145, May.
    2. Ariful Hoque, 2011. "Transaction Cost Discovery By Decomposition Of The Error Term: A Bootstrapping Approach," The International Journal of Business and Finance Research, The Institute for Business and Finance Research, vol. 5(1), pages 113-121.

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    More about this item

    Keywords

    Foreign currency options; implied volatility; optimal volatility; multiplicative error model; GARCH model;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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