Accounting for the impact of higher order moments in foreign equity option pricing model

Abstract

This paper investigates the pricing of foreign equity option whose value depends on foreign equity prices and exchange rate. We assume that the underlying asset returns of foreign equity option is not a Brownian motion, and use the Gram–Charlier series expansion to augment a normal density with two additional terms to capture the effects of skewness and kurtosis. The empirical study shows that the higher order moments (skewness and kurtosis) clearly affect the estimated prices of foreign equity options. This approach enables us to capture more accurately the foreign equity option prices.