Stochastic Skew in Currency Options
48 Pages Posted: 30 Jun 2004
Date Written: May 13, 2004
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: Suggested Citation