The performance of alternative valuation models in the OTC currency options market
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.
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Related Subject Headings
- Finance
- 3801 Applied economics
- 3502 Banking, finance and investment
- 1502 Banking, Finance and Investment
- 1403 Econometrics
- 1402 Applied Economics
Citation
Published In
DOI
ISSN
Publication Date
Volume
Issue
Start / End Page
Related Subject Headings
- Finance
- 3801 Applied economics
- 3502 Banking, finance and investment
- 1502 Banking, Finance and Investment
- 1403 Econometrics
- 1402 Applied Economics