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Currency Option Pricing with Stochastic Domestic and Foreign Interest Rates

Published online by Cambridge University Press:  06 April 2009

Jimmy E. Hilliard ,
Jeff Madura  and
Alan L. Tucker
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Abstract

This study develops a currency option pricing model under stochastic interest rates when interest rate parity holds, and it is assumed that domestic and foreign bond prices have local variances that depend only on time. We demonstrate how existing currency option models are simply derived from one framework. Empirical tests employing transactions option data reveal that a particularly simple form of the stochastic rate model is uniformly more accurate than a constant rate model for all boundaries and maturities tested.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 26 , Issue 2 , June 1991 , pp. 139 - 151
Copyright
Copyright © School of Business Administration, University of Washington 1991

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