Title: Do simple traders' rules perform better than the GARCH model? Evidence from currency options in India

Authors: Aparna Bhat

Addresses: Department of Finance, K.J. Somaiya Institute of Management Studies and Research, Vidyavihar, Mumbai, 400-077, India

Abstract: The moneyness and maturity biases empirically observed in the case of the Black-Scholes-Merton (BSM) model have led to the evolution of alternative option-pricing models that attempt to address the shortcomings of the BSM model. One such alternative model is the GARCH model of Duan (1995) which takes into account the heteroscedastic nature of volatility. This paper examines the pricing performance of Duan's GARCH model in the context of exchange-traded currency options traded in India. The comparison is made with the 'sticky-strike' and 'sticky-delta' models used by practitioners. These models recognise implied volatility as a function of the option's strike price and time to maturity and are easier to implement than the GARCH model which is computationally intensive. The study finds that the practitioners' models fare better than the more sophisticated GARCH model in pricing currency options in an emerging market like India. The contribution of this paper lies in the fact that it is one of the few studies that focuses on the empirical performance of the GARCH model in pricing currency options and the only study in the context of currency options in India.

Keywords: currency options; GARCH option-pricing model; sticky-strike; sticky-delta; dollar-rupee options; India.

DOI: 10.1504/IJFMD.2018.091680

International Journal of Financial Markets and Derivatives, 2018 Vol.6 No.3, pp.183 - 209

Received: 31 May 2017
Accepted: 23 Sep 2017
Published online: 11 May 2018 *

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