Modeling Volatility in Foreign Currency Option Pricing

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.(JEL: G12, G13)

Econometric Modeling for Transaction Cost-Adjusted Put-Call Parity: Evidence from the Currency Options Market

“…Furthermore, accurate market prices can be used as the market's best forecast for future options prices (Hoque et al, 2009). The efficiency of an options market can be determined by testing the PCP relationship under the conditions, in which the market is assumed to be frictionless.…”