Abstract
AbstractWe study the implied volatilities of three foreign exchange (FX) option markets: EUD/USD, GBP/USD, and AUD/USD. We find that they are distinct from each other. The implied volatilities of the EUD/USD market tend to be more U‐shaped than those of other markets. Local volatility models such as the constant elasticity of variance (CEV) model and stochastic volatility models, such as the Heston model, may fail to capture this type of convexity. We choose a stochastic‐local volatility model to obtain an implied volatility formula for the corresponding FX options. The formula is given by the CEV formula with additional terms reflecting the (pure) stochastic volatility nature of FX rates. Based on this result, we show that the stochastic‐local volatility model is a suitable universal choice for the pricing of these FX options.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callMore From: Applied Stochastic Models in Business and Industry
Disclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
