Pricing Currency Options with Bates Model: Analytical Tractability versus Empirical Misspeci cation

University essay from Göteborgs universitet/Graduate School

Author: Oscar Thelander; [2021-02-02]

Keywords: ;

Abstract: In this thesis I complement the results from Bates (1996) wherein a Stochastic VolatilityJump-Di usion model for pricing foreign currency options is introduced and evaluated againstUSD/DM foreign exchange options. I complement Bates results with two di erent calibrationmethodologies, nonlinear least-squares and the built-in MATLAB function fmincon, using thesame dataset that was used in Bates (1996). The results shows that the nonlinear least-squarescalibration exhibit parameter values closely related to that of Bates (1996) and performs wellwhen testing the pricing performance across moneyness, thus con rming Bates results. For thefmincon calibration, certain implicit parameter values are improbable given the model spec-i cation. This also corresponds to a comparatively worse pricing performance than that oflsqnonlin and an overall inconsistent pricing with respect to theoretical interpretation.

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