Option pricing on foreign exchange in a Markov-modulated, incomplete-market economy

Lian, Yu-Min; Chen, Jun-Home; Liao, Szu-Lang

doi:10.1016/j.frl.2015.12.005

Cited by 14 publications

(5 citation statements)

References 12 publications

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“…Similarly, Lian et al (2016) introduce a stochastic volatility model for pricing FX derivatives, which is consistent with stylized facts (smiles, skews, and symmetries) of the FX market. The authors extend the Esscher transform technique to obtain analytical pricing formulas based on solving a system of Markov-modulated Esscher parameters.…”

Section: Options Pricing Modelmentioning

confidence: 87%

Analysing Intraday Implied Volatility for Pricing Currency Options

Le¹

2021

Contributions to Finance and Accounting

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This research analyses the intraday implied volatility (IV) for pricing currency options. It conducts analyses in three steps. First, estimates at-the-money IV using the price of options with one-month, two-month, and three-month maturity during the opening, midday, and closing period of a trading day. Second, the Mincer-Zarnowitz regression test assessing the performance of IV to forecast the volatility of the underlying currency of options for the withinweek, one-week, and one-month forecast horizon. Third, mean absolute error (MAE), mean squared error (MSE), and root mean squared error (RMSE) measures evaluating the performance of IV to estimate the price of currency options for the within-week, one-week, and one-month estimate horizon. It employs Australian dollar, British pound, Canadian dollar, Euro, and Swiss franc options trading from 01 January 2010 to 31 December 2017. This study reveals four critical findings. First, three-month maturity IV does not contain useful information about future volatility of the underlying currency and pricing currency options.Second, IV incorporates all information is not relevant to compute the price of currency options for less than a week estimate horizon. Third, IV of the closing period on Monday or Tuesday subsumes most of the essential information compared to other periods of a trading day and other days of a week to forecast volatility of the underlying currency and estimate the value of currency options. Fourth, the shorter (longer) maturity IV holds vital information to price currency options for the shorter (longer) estimate horizon. The overall research findings imply that the information content embedded in one-month and two-month maturity IV is appropriate to calculate the currency options price for the one-week and one-month estimate horizon, respectively. The intraday IV approach adds a new dimension to obtain the unobservable volatility in pricing currency options accurately for the researchers and practitioners. v

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Section: Options Pricing Modelmentioning

confidence: 87%

Analysing Intraday Implied Volatility for Pricing Currency Options

Le¹

2021

Contributions to Finance and Accounting

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“…Liu (2017) conducted an empirical study using Markov-modulated regime switching model on Hang Seng index options when the regime switching risk is priced. In recent years, regimeswitching models have been extended to include a jump-diffusion process (Momeya, e al., 2016), or price different types of options, for instance, bond options (Shen, et al, 2013), currency options (Bo, et al, 2010;Liu, 2019), and foreign equity options (Lian, et al, 2016;Fan, et al, 2014).…”

Section: Introductionmentioning

confidence: 99%

Empirical Study on Option Pricing under Markov Regime Switching Economics

Liu¹

2024

AAM

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In this research, we summarize the results of a practical study of index options based on the option valuation model which was proposed by Siu and Yang (Acta Math. Appl. Sin. Engl. Ser., 25(3) (2009), pp. 339-388), where an EMM kernel is integrated which takes into account all risk components of a regime-switching model. Further, the regime-switching risk of an economy in the options is priced using a hidden Markov regime-switching model with the risky underlying asset being modulated by a discrete-time, finite-state, hidden Markov chain whose states represent the hidden states of an economy. We apply such a model to the pricing of Hang Seng Index options based on the realworld financial data from October 2009 to October 2010 (i.e., for the year in which the model was proposed). We employed the entropy martingale measure (EMM) approach proposed by Siu and Yang (Acta Math. Appl. Sin. Engl. Ser., 25(3) (2009), pp. 339-388) to determine the optimal martingale measure for the Markov-modulated GBM. In addition, we have proposed a numerical technique called the weighted difference method to compliment the EMM approach. We have also verified the extended jump-diffusion model under regime-switching that we proposed recently (Int. J. Finan. Eng., 6(4) (2019), 1950038) using the 50ETF options which are obtained from Shanghai Stock Exchange covering a time span from January 2018 to December 2022. Further, we have highlighted the challenges for the EMM kernel-based Markov regime-switching model for pricing the out-of-the-money index options in the real world.

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“…Various authors assumed regime switching models and addressed theoretical option pricing and portfolio optimization problems following Di Masi et al (1995). For details, the readers may refer to Basak et al (2011), Bo et al (2010), Fan et al (2014), Jobert and Rogers (2006), Li and Ma (2013), Lian et al (2016), Papin and Turinici (2014), Siu et al (2008), Su et al (2012), Swishchuk et al (2014), Wang et al (2016) and Yuen and Yang (2009). This list is merely indicative and not exhaustive by any means.…”

Section: Introductionmentioning

confidence: 99%

Testing of binary regime switching models using squeeze duration analysis

Das

Goswami

2019

J. Finan. Eng.

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We have developed a statistical technique to test the model assumption of binary regime switching extension of the geometric Brownian motion (GBM) model by proposing a new discriminating statistics. Given a time series data, we have identified an admissible class of the regime switching candidate models for the statistical inference. By performing several systematic experiments, we have successfully shown that the sampling distribution of the test statistics differs drastically, if the model assumption changes from GBM to Markov modulated GBM, or to semi-Markov modulated GBM. Furthermore, we have implemented this statistics for testing the regime switching hypothesis with Indian sectoral indices.

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Option pricing on foreign exchange in a Markov-modulated, incomplete-market economy

Cited by 14 publications

References 12 publications

Analysing Intraday Implied Volatility for Pricing Currency Options

Analysing Intraday Implied Volatility for Pricing Currency Options

Empirical Study on Option Pricing under Markov Regime Switching Economics

Testing of binary regime switching models using squeeze duration analysis

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