Currency derivatives under a minimal market model with random scaling

World Scientific Publishing Company
Publication Type:
Journal Article
International Journal of Theoretical and Applied Finance, 2005, 8 (8), pp. 1157 - 1177
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This paper uses an alternative, parsimonious volatility model to describe the dunamics of a currency market for the pricing and hedging of derivatives. Time transformed squared Bessel processes are the basic driving factors of the minimal marketr model. The time transformation is chracterised by a random scaling, wich provides for realistic exchange rate dynamics. The pricing of standard European options is studied. In particular, it is shown that the model produces implied volatility surfaces that are tpically observed in real markets.
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