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A Linear Regression Approach for Determining Option Pricing for Currency-Rate Diffusion Model with Dependent Stochastic Volatility, Stochastic Interest Rate, and Return Processes
Department of Management Sciences, Tippie College of Business, The University of Iowa, Iowa City, USA
- 1 Department of Management Sciences, Tippie College of Business, The University of Iowa, Iowa City, USA
Journal of Mathematical Finance·Volume 08 (2018)·Pages 161–177·Published 18 January 2018·DOI10.4236/jmf.2018.81013
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Abstract
A three-factor exchange-rate diffusion model that includes three stochastically-dependent Brownian motion processes, namely, the domestic interest rate process, volatility process and return process is considered. A linear regression approach that derives explicit expressions for the distribution function of log return of foreign exchange rate is derived. Subsequently, a closed form workable formula for the call option price that has an algebraic expression similar to a Black-Scholes model, which facilitates easier study, is discussed.
KeywordsOption PricingInterest-Rate Parity ConditionBlack-Scholes ModelLinear Regression ApproachSpot OptionIto Calculus
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