An Empirical Examination of the Variance-Gamma Model for Foreign Currency Options

We apply the variance-gamma (VG) option-pricing model to currency options. The model is a pure infinite-activity jump model. We examine whether and to what extent this new model can improve the pricing quality for currency options over the existing modified Black-Scholes model and the Merton jump-diffusion (JD) model. We find that the VG model yields better out-of-sample pricing performance than the modified Black-Scholes model or the JD model. In addition, a cross-entropy analysis shows that the VG model is more consistent with the general criterion of utility maximization and optimal portfolio selection.