Due to the mispricing of options, no-arbitrage condition put-call parity (PCP) violations lead to inefficiency in the currency options market. Through transaction costs, the effects of these violations are reduced to negligible levels, indicating that PCP is not a sufficient condition for an...

This paper proposes a preference-based general equilibrium model that explains various pricing features of currency and currency options. The central ingredients are i) a variable disaster component that is highly but imperfectly shared across countries; and ii) the separation of EIS from risk...

Recent empirical studies report predictable dynamics in the volatility surfaces implied by observed index option prices, as prescribed by general equilibrium models. Using an extensive data set from the over-the-counter options market, we document similar predictability in the factors that...

In this paper, we present a stochastic volatility model with stochastic interest rates in a Foreign Exchange (FX) setting. The instantaneous volatility follows a mean-reverting Ornstein–Uhlenbeck process and is correlated with the exchange rate. The domestic and foreign interest rates are...

Liquidity being an elusive concept is often difficult to measure, and it becomes even vaguer in currency options market which provides investors an alternative to hedge against foreign exchange fluctuations. Over past few years since the starting of trading of currency options contracts on US...

Volatility implied from observed option contracts systematically varies with the contracts' strike price and time to expiration, giving rise to an instantaneously non-flat implied volatility surface (IVS) that exhibits substantial time variation. We identify a number of latent factors that drive...

The implied volatility (IV) estimation process suffers from an obvious chicken-egg dilemma: obtaining an unbiased IV requires the options to be priced correctly and calculating an accurate option price requires an unbiased IV. We address this critical issue in two steps. First, the Granger...

The purpose of this paper is to examine the effect of illiquidity on the value of currency options. We use a unique dataset that allows us to explore this issue in special circumstances where options are issued by a central bank and are not traded prior to maturity. The value of these options is...

Spot foreign exchange (FX) rates usually exhibit volatility clustering and regime switching in a finite number of states due to change in macroeconomic factors or financial crises. We provide regime-switching evidence based on yield-curves data under the Markov-modulated diffusion (MMD) model. A...

The currency options markets, both the dollar denominated options markets and the cross-currency options markets, carry important economic information about the evolution of exchange rates and the pricing of risk. However, it is challenging to integrate all this information together. This paper...