Pricing foreign equity option with stochastic volatility

• We propose a general foreign equity option pricing framework.
• The time-changed Levy processes are used to model the underlying assets price in our model.
• The closed form pricing formula is obtained through the use of characteristic function technology.
• Numerical tests show that our model is effective on foreign equity option pricing.

In this paper we propose a general foreign equity option pricing framework that unifies the vast foreign equity option pricing literature and incorporates the stochastic volatility into foreign equity option pricing. Under our framework, the time-changed Lévy processes are used to model the underlying assets price of foreign equity option and the closed form pricing formula is obtained through the use of characteristic function methodology. Numerical tests indicate that stochastic volatility has a dramatic effect on the foreign equity option prices.