The performance of alternative valuation models in the OTC currency options market


Journal Article

We compare option valuation models based on regime-switching, GARCH, and jump-diffusion processes to a standard "smile" model, in which Black and Scholes (1973) implied volatilities are allowed to vary across strike prices. The regime-switching, GARCH, and jump-diffusion models provide significant improvement over a fixed smile model in fitting GBP and JPY option prices both in-sample and out-of-sample. The jump-diffusion model achieves the tightest fit. A time-varying smile model, however, provides hedging performance that is comparable to the other models for the GBP options. This result suggests that standard option valuation techniques may provide a reasonable basis for trading and hedging strategies. © 2003 Elsevier Science Ltd. All rights reserved.

Full Text

Duke Authors

Cited Authors

  • Bollen, NPB; Rasiel, E

Published Date

  • January 1, 2003

Published In

Volume / Issue

  • 22 / 1

Start / End Page

  • 33 - 64

International Standard Serial Number (ISSN)

  • 0261-5606

Digital Object Identifier (DOI)

  • 10.1016/S0261-5606(02)00073-6

Citation Source

  • Scopus