Quanto Option Pricing with Lévy Models

Posted: 20 Jun 2016 Last revised: 2 Apr 2018

See all articles by Hasan Fallahgoul

Hasan Fallahgoul

Monash University

Young Shin Kim

State University of New York, SUNY at Stony Brook University, College of Business

Frank J. Fabozzi

EDHEC Business School

Jiho Park

State University of New York, SUNY at Stony Brook University, College of Business

Date Written: June 8, 2017

Abstract

We develop a multivariate Lévy model and apply the bivariate model for the pricing of quanto options that captures three characteristics observed in real-world markets for stock prices and currencies: jumps, heavy tails and skewness. The model is developed by using a bottom-up approach from a subordinator. We do so by replacing the time of a Brownian motion with a Lévy process, rapidly decreasing subordinator. We refer to this model as a multivariate rapidly decreasing Lévy process. We then compare using a time series of daily log-returns and market prices of European-style quanto options the relative performance of the rapidly decreasing Lévy process to that of the Black-Scholes and the normal tempered stable process. We find that, due to more flexibility on capturing the information of tails and skewness, the proposed modeling process is superior to the other two processes for fitting market distribution and pricing quanto options.

Keywords: Quanto option pricing, L'evy process, stable and tempered stable process, subordinator

JEL Classification: C0, C02, C1

Suggested Citation

Fallahgoul, Hasan A and Kim, Young Shin and Fabozzi, Frank J. and Park, Jiho, Quanto Option Pricing with Lévy Models (June 8, 2017). Available at SSRN: https://ssrn.com/abstract=2797540 or http://dx.doi.org/10.2139/ssrn.2797540

Hasan A Fallahgoul (Contact Author)

Monash University ( email )

Clayton Campus
Victoria, 3800
Australia

HOME PAGE: http://www.hfallahgoul.com

Young Shin Kim

State University of New York, SUNY at Stony Brook University, College of Business ( email )

306 Harriman Hall
Stony Brook, NY 11794
United States

Frank J. Fabozzi

EDHEC Business School ( email )

France
215 598-8924 (Phone)

Jiho Park

State University of New York, SUNY at Stony Brook University, College of Business ( email )

306 Harriman Hall
Stony Brook, NY 11794
United States

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