Journal of Applied Mathematics

Pricing Currency Option Based on the Extension Principle and Defuzzification via Weighting Parameter Identification

Jixiang Xu, Yanhua Tan, Jinggui Gao, and Enmin Feng

Full-text: Open access

Abstract

We present a fuzzy version of the Garman-Kohlhagen (FG-K) formula for pricing European currency option based on the extension principle. In order to keep consistent with the real market, we assume that the interest rate, the spot exchange rate, and the volatility are fuzzy numbers in the FG-K formula. The conditions of a basic proposition about the fuzzy-valued functions of fuzzy subsets are modified. Based on the modified conditions and the extension principle, we prove that the fuzzy price obtained from the FG-K formula for European currency option is a fuzzy number. To simplify the trade, the weighted possibilistic mean (WPM) value with a weighting function is adopted to defuzzify the fuzzy price to a crisp price. The numerical example shows our method makes the α-level set of fuzzy price smaller, which decreases the fuzziness. The example also indicates that the WPM value has different approximation effects to real market price by taking different values of weighting parameter in the weighting function. Inspired by this example, we provide a method, which can identify the optimal parameter.

Article information

Source
J. Appl. Math., Volume 2013 (2013), Article ID 623945, 9 pages.

Dates
First available in Project Euclid: 14 March 2014

Permanent link to this document
https://projecteuclid.org/euclid.jam/1394807886

Digital Object Identifier
doi:10.1155/2013/623945

Zentralblatt MATH identifier
1266.91027

Citation

Xu, Jixiang; Tan, Yanhua; Gao, Jinggui; Feng, Enmin. Pricing Currency Option Based on the Extension Principle and Defuzzification via Weighting Parameter Identification. J. Appl. Math. 2013 (2013), Article ID 623945, 9 pages. doi:10.1155/2013/623945. https://projecteuclid.org/euclid.jam/1394807886


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