Jointly Modeling American Depository Receipts, the Local Stock and the Local Price of the US Dollar
20 Pages Posted: 18 Mar 2013
Date Written: August 25, 2012
Abstract
Options on an ADR reflect the correlations between the local stock and the foreign currency price of the US dollar while local option surfaces calibrate the marginal laws. After developing a general procedure for pricing all three sets of options from a model for the joint law on the local stock and USD quoted locally we investigate the convergence of market to model. A rich joint law with 13 parameters building on Bhattacharyya (1944) is employed. It is observed that the Bhattacharya (1944) model has squared correlations rising to unity in the tails, a desirable feature for financial data. Such convergence of market to model appears to have been present for Santander over the period October 2010 to March 2012.
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