Author(s)

Raj Jagannathan

Department of Management Sciences, Tippie College of Business, The University of Iowa, Iowa City, USA.

A three-factor exchange-rate diffusion model that includes three stochastically-dependent Brownian motion processes, namely, the domestic interest rate process, volatility process and return process is considered. A linear regression approach that derives explicit expressions for the distribution function of log return of foreign exchange rate is derived. Subsequently, a closed form workable formula for the call option price that has an algebraic expression similar to a Black-Scholes model, which facilitates easier study, is discussed.

Option Pricing, Interest-Rate Parity Condition, Black-Scholes Model, Linear Regression Approach, Spot Option, Ito Calculus

Jagannathan, R. (2018) A Linear Regression Approach for Determining Option Pricing for Currency-Rate Diffusion Model with Dependent Stochastic Volatility, Stochastic Interest Rate, and Return Processes. Journal of Mathematical Finance, 8, 161-177. doi: 10.4236/jmf.2018.81013.