University of Western Sydney

School of Computing, Engineering and Mathematics Seminars

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Pricing Foreign Exchange Options in Heston's Model with Cox Ross Ingersoll Interest Rates

Speaker: Rehez Ahlip

Affiliation: University of Western Sydney

Time: Monday 03/05/2010 from 14:00 to 15:00

Venue: The dungeon (EC.G.23), Parramatta UWS

Abstract: Foreign exchange options are studied in the Heston stochastic
volatility model for the exchange rate combined with the Cox,
Ingersoll and Ross dynamics for the domestic and foreign stochastic
interest rates. The instantaneous volatility is correlated with the
dynamics of the exchange rate return, whereas the domestic and foreign
short-term rates are assumed to be independent of the dynamics of the
exchange rate. The main result furnishes a semi-analytical formula
for the price of the foreign exchange European call option. It is
derived using the probabilistic approach combined with the Fourier
inversion technique, as developed in Carr and Madan. We argue that
the model examined in this paper is the only analytically tractable
version of the foreign exchange market model, which combines the
Heston stochastic volatility model for the exchange rate with the CIR
dynamics for interest rates.

Biography: Rehez Ahlip is a Senior Lecturer with the School of Computing, Engineering and Mathematics and a member of the UWS Centre for Research in Mathematics. His research is in the area of financial mathematics that defines pricing and hedging of derivatives. For the last 7 years Rehez has been collaborating with Professor Marek Rutkowski from The University of Sydney on developing mathematical models for pricing of foreign exchange options of increasing sophistication. As the result of this research Rehez has published a number of well received journal papers.

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