Hostname: page-component-78c5997874-4rdpn Total loading time: 0 Render date: 2024-11-15T07:03:21.376Z Has data issue: false hasContentIssue false
  • English
  • Français

Tests of an American Option Pricing Model on the Foreign Currency Options Market

Published online by Cambridge University Press:  06 April 2009

James N. Bodurtha Jr  and
Georges R. Courtadon
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper tests the ability of the American option pricing model proposed by Parkinson [18] or Mason [14] to explain the pricing of the foreign currency options traded on the Philadelphia Stock Exchange from February 28, 1983 to March 26, 1985. We find that the model underprices out-of-the-money options relative to at-the-money and in-the-money options. This relative underpricing is driven by an underpricing of out-of-the-money call options of short maturity. In addition, the degree of relative mispricing for most categories of options is shown to be a decreasing function of the time to maturity of the options. Longer maturity options appear to trade at similar levels of implied volatility whether they are in, at, or out of the money. Most of these biases appear consistent with the fact that the underlying spot currency rate follows a mixed jump diffusion process as described in [17].

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 22 , Issue 2 , June 1987 , pp. 153 - 167
Copyright
Copyright © School of Business Administration, University of Washington 1987

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

REFERENCES

[1]Ball, C. A., and Torous, W. N.. “On Jumps in Common Stock Prices and Their Impact on Call Pricing.” Journal of Finance, 40 (03 1985), 155–173.CrossRefGoogle Scholar
[2]Beckers, S. “A Note on Estimating the Parameters of the Diffusion Jump Model of Stock Returns.” Journal of Financial and Quantitative Analysis, 16 (03 1981), 127–140.CrossRefGoogle Scholar
[3]Black, F., and Scholes, M.. “The Pricing of Options and Contingent Claims.” Journal of Political Economy, 81 (05/06 1973), 637–654.CrossRefGoogle Scholar
[4]Bodurtha, J. N. Jr., “PHLX Currency Option Surveillance Report and OCC Exercise History: A Data Base.” Mimeograph, The Ohio State Univ. (1985).Google Scholar
[5]Chiras, D. P., and Manaster, S.. “The Information Content of Option Prices and a Test of Market Efficiency.” Journal of Financial Economics, 6 (06/09 1978), 213–234.CrossRefGoogle Scholar
[6]Cornell, B., and Reinganum, M. R.. “Forward and Futures Prices: Evidence from the Foreign Exchange Markets.” Journal of Finance, 36 (12 1981), 1035–1045.CrossRefGoogle Scholar
[7]Feiger, G., and Jacquillat, B.. “Currency Option Bonds, Puts and Calls on Spot Exchange and the Hedging of Contingent Foreign Earnings.” Journal of Finance, 34 (12 1979), 1129–1139.CrossRefGoogle Scholar
[8]Garman, M., and Kohlhagen, S.. “Foreign Currency Option Values.” Journal of International Money and Finance, 2 (12 1983), 231–237.CrossRefGoogle Scholar
[9]Geske, R. “A Note on an Analytical Valuation Formula for Unprotected American Call Options on Stocks with Known Dividends.” Journal of Financial Economics, 7 (12 1979), 375–380.CrossRefGoogle Scholar
[10]Geske, R., and Roll, R.. “On Valuing American Call Options with the Black-Scholes European Formula.” Journal of Finance, 39 (06 1984), 443–455.Google Scholar
[11]Grabbe, J. O. “The Pricing of Call and Put Options on Foreign Exchange.” Journal of International Money and Finance, 2 (12 1983), 239–253.CrossRefGoogle Scholar
[12]Kendall, Sir M., and Stuart, A.. The Advanced Theory of Statistics. New York: MacMillan Publ. Co., Inc. (1979).Google Scholar
[13]Macbeth, J. C., and Merville, L. J.. “An Empirical Estimation of the Black-Scholes Call Option Pricing Model.” Journal of Finance, 34 (12 1979), 1173–1185.Google Scholar
[14]Mason, S. P. “Essays in Continuous Time Finance.” Ph.D. Dissertation, M.I.T. (1979).Google Scholar
[15]McCulloch, J. H. “The Value of European Options with Log-Stable Uncertainty.” Unpubl. Working Paper, The Ohio State Univ. (1985).Google Scholar
[16]Merton, R. C. “The Theory of Rational Option Pricing.” Bell Journal of Economics, 4 (Spring 1973), 141–183.Google Scholar
[17]Merton, R. C. “The Impact on Option Pricing of Specification Error in the Underlying Stock Price Returns.” Journal of Finance, 31 (05 1976), 333–350.CrossRefGoogle Scholar
[18]Parkinson, M. “Option Pricing: The American Put.” Journal of Business, 50 (01 1977), 21–36.CrossRefGoogle Scholar
[19]Phillips, S. M., and Smith, C. W. Jr,. “Trading Costs for Listed Options. The Implications for Market Efficiency.” Journal of Financial Economics, 8 (06 1980), 179–201.CrossRefGoogle Scholar
[20]Roll, R. “An Analytical Valuation Formula for Unprotected American Call Options on Stocks with Known Dividends.” Journal of Financial Economics, 5 (11 1977), 251–258.CrossRefGoogle Scholar
[21]Rubinstein, M. “Non Parametric Tests of Alternative Option Pricing Models Using All Reported Trades and Quotes on the 30 Most Active CBOE Option Classes from August 23, 1976 through August 31, 1978.” Journal of Finance, 40 (06 1985), 455–480.CrossRefGoogle Scholar
[22]Schwartz, E. S. “The Valuation of Warrants: Implementing a New Approach.” Journal of Financial Economics, 4 (01 1977), 79–93.CrossRefGoogle Scholar
[23]Shastri, K., and Tandon, K.. “Valuation of Foreign Currency Options: Some Empirical Tests.” Grad. School of Business, Univ. of Pittsburgh (02 1984).Google Scholar
[24]Shastri, K., and Tandon, K.. “Valuation of American Options on Foreign Currency.” Grad. School of Business, Univ. of Pittsburgh (06 1985).Google Scholar
[25]Sterk, W. E. “Comparative Performance of the Black-Scholes and Roll-Geske-Whaley Option Pricing Models.” Journal of Financial and Quantitative Analysis, 18 (09 1983), 345–354.CrossRefGoogle Scholar
[26]Whaley, R. E. “On the Valuation of American Call Options on Stocks with Known Dividends.” Journal of Financial Economics, 9 (06 1981), 207–211.CrossRefGoogle Scholar
[27]Whaley, R. E. “Valuation of American Call Options on Dividend-Paying Stocks: Empirical Tests.” Journal of Financial Economics, 10 (03 1982), 29–58.CrossRefGoogle Scholar