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Jumps and Stochastic Volatility: Exchange Rate Processes Implicit in Deutschemark Options

REVIEW OF FINANCIAL STUDIES, Vol. 9 No. 1

Posted: 22 Aug 1998  

David S. Bates

University of Iowa - Department of Finance; National Bureau of Economic Research (NBER)

Abstract

An efficient method is developed for pricing American options on stochastic volatility/jump-diffusion processes under systematic jump and volatility risk. The parameters implicit in Deutschemark options of the model and various submodels are estimated over 1984-91 via nonlinear generalized least squares, and are tested for consistency with $/DM futures prices and the implicit volatility sample path. The stochastic volatility submodel cannot explain the "volatility smile" evidence of implicit excess kurtosis, except under parameters implausible given the time series properties of implicit volatilities. Jump fears can explain the smile, and are consistent with one 8% DM appreciation "outlier" observed over 1984-91.

JEL Classification: G14

Suggested Citation

Bates, David S., Jumps and Stochastic Volatility: Exchange Rate Processes Implicit in Deutschemark Options. REVIEW OF FINANCIAL STUDIES, Vol. 9 No. 1. Available at SSRN: https://ssrn.com/abstract=6913

David S. Bates (Contact Author)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of Iowa - Department of Finance ( email )

Iowa City, IA 52242-1000
United States
319-353-2288 (Phone)
319-335-3690 (Fax)

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