Author(s)

Topilista Nabirye¹, Philip Ngare², Joseph Mungatu³

¹Pan African University, Institute of Basic Science, Technology and Innovation, JKUAT, Nairobi, Kenya.
²School of Mathematics, University of Nairobi, Nairobi, Kenya.
³Department of Statistics, School of Mathematics, Jomo Kenyatta University of Agriculture and Technology, Nairobi, Kenya.

Financial markets are known to be far from deterministic but stochastic and hence time dependent correlation tends to suit the markets. We price for European Options by using three dimensional assets under stochastic correlation. The pricing equations under constant correlation and stochastic correlation are derived numerically by using finite difference method called the Crank Nicolson method. We compare the pricing equations when the correlation is stochastic and constant by using real data from emerging financial markets, that is, exchange rates data for Kenya as the domestic currency and South Africa as the foreign currency. Pricing equation for the European option with stochastic correlation performed better than that with constant correlation.

Foreign Exchange, European Option, Stochastic Correlation and Option Pricing

Nabirye, T. , Ngare, P. and Mungatu, J. (2016) Foreign Exchange Derivative Pricing with Stochastic Correlation. Journal of Mathematical Finance, 6, 887-899. doi: 10.4236/jmf.2016.65059.