Modeling fx options in presence of stochastic volatility with overnight-indexed-swap-discounting

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2019

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Tekten, Selin

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This study investigates the time contingent behavior of risk factor USDTRY. Option pricing models Black-Scholes and Heston has been utilized to estimate the behavior. The adjusted Black-Sholes model is the current market practice to model USDTRY risk factor. Market practitioners do not prefer to use constant volatility in the Black-Scholes Model, which violates the model assumption. They instead interpolate the volatility surface from market data of implied volatilities and use them in Black-Scholes Model. However, Heston model admits varying volatilities. The Heston Model adds a dimension to the Black-Scholes model by letting the volatility to be a stochastic process. In this thesis, we have used interpolated volatility surface as a benchmark for testing the results estimated by the Heston Model. Furthermore, while estimating option prices, Overnight-Indexed-Swap (OIS) discounting framework has been governed to achieve risk-free rates. The test results have indicated that Heston stochastic volatility model with OIS discounting offers arbitrage-free pricing with similar computation efficiency to the benchmark.

Subject Keywords

Options (Finance), Options (Finance) Prices, Options (Finance) Prices Mathematical models., Currency Options, USDTRY, Heston Model, Overnight-Indexed-Swap Discounting, Volatility Surface

URI

http://etd.lib.metu.edu.tr/upload/12624997/index.pdf
https://hdl.handle.net/11511/45325

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Graduate School of Applied Mathematics, Thesis

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Citation Formats

S. Tekten, “Modeling fx options in presence of stochastic volatility with overnight-indexed-swap-discounting,” Thesis (M.S.) -- Graduate School of Applied Mathematics. Financial Mathematics., Middle East Technical University, 2019.