Pricing Currency Options in Tranquil Markets: Modelling Volatility Frowns Lim, G.C. Martin, Gael M. Martin, V.L. 10.4225/03/5934ba5861f61 https://bridges.monash.edu/articles/journal_contribution/Pricing_Currency_Options_in_Tranquil_Markets_Modelling_Volatility_Frowns/5072509 Volatility smiles arise in currency option markets when empirical exchange rate returns distributions exhibit leptokurtosis. This feature of empirical distributions is symptomatic of turbulent periods when exchange rate movements are in excess of movements based on the assumption of normality. In contrast, during periods of tranquility, movements in exchange rates are relatively small, resulting in unconditional empirical returns distributions with thinner tails than the normal distribution. Pricing currency options during tranquil periods on the assumption of normal returns yields implied volatility frowns, with over-pricing at both deep-in and deep-out-of-the-money contracts and under-pricing for at-the-money contracts. This paper shows how a parametric class of thin-tailed distributions based on the generalised Student t family of distributions can price currency options during periods of tranquility. 2017-06-05 01:56:39 Volatility frowns Thin-tails Generalised Student t 2002 Option pricing 1959.1/2321 monash:2321