Stochastic Skew in Currency Options

48 Pages Posted: 30 Jun 2004

See all articles by Liuren Wu

Liuren Wu

City University of New York, CUNY Baruch College - Zicklin School of Business

Peter Carr

New York University Finance and Risk Engineering

Multiple version iconThere are 2 versions of this paper

Date Written: May 13, 2004

Abstract

We document the behavior of over-the-counter currency option prices across moneyness, maturity, and calendar time on two of the most actively traded currency pairs over the past eight years. We find that on any given date, the conditional risk-neutral distribution of currency returns can show strong asymmetry. This asymmetry varies greatly over time and often switches signs. We develop and estimate a class of models that captures this stochastic skew behavior. Model estimation shows that our stochastic skew models significantly outperform traditional jump-diffusion stochastic volatility models both in-sample and out-of-sample.

Keywords: Currency options, Foreign exchange dynamics; Stochastic skew; Stochastic volatility; Time-changed Levy processes.

JEL Classification: G12, G13, F31, C52.

Suggested Citation

Wu, Liuren and Carr, Peter P., Stochastic Skew in Currency Options (May 13, 2004). EFA 2004 Maastricht Meetings Paper No. 1426. Available at SSRN: https://ssrn.com/abstract=559404 or http://dx.doi.org/10.2139/ssrn.559404

Liuren Wu (Contact Author)

City University of New York, CUNY Baruch College - Zicklin School of Business ( email )

One Bernard Baruch Way
Box B10-247
New York, NY 10010
United States
646-312-3509 (Phone)
646-312-3451 (Fax)

HOME PAGE: http://faculty.baruch.cuny.edu/lwu/

Peter P. Carr

New York University Finance and Risk Engineering ( email )

6 MetroTech Center
Brooklyn, NY 11201
United States
9176217733 (Phone)

HOME PAGE: http://engineering.nyu.edu/people/peter-paul-carr

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