TESTS OF THE BLACK-SCHOLES AND CONSTANT ELASTICITY OF VARIANCE CURRENCY CALL OPTION VALUATION MODELS

An adaptation of the Cox-Ross/Emanuel-MacBeth call option valuation model for constant elasticity of variance diffusion processes is tested here against an adaptation of the Black-Scholes call option valuation model for the pricing of call currency options. Synchronized transactions data supplied by the Philadelphia Exchange are used. A maximum likelihood estimation procedure indicates a significant association between currency return variances and exchange rate levels. The constant elasticity of variance model exhibits significantly superior pricing accuracy for predictive intervals of three or fewer trading days.     

DIVIDENDS, DIVIDEND POLICY AND OPTION VALUATION: A NEW PERSPECTIVE

This paper develops a model which explicitly incorporates the impact of the payment of dividends on the underlying stock into the valuation of both American and European calls and puts. Unlike earlier models, what we call the Dividend Adjustment Merton (DAM) model neither assumes arbitrary continuous dividends nor uses ad hoc methods to adjust for discrete dividend payments. Instead, it assumes the existence of a Miller and Modigliani (1961) valuation neutral dividend policy and adjusts Merton's constant proportional dividend model to incorporate any known schedule of discrete cash dividends of this type. The DAM model produces results which are equal to or superior to those of the separate models now used to value American calls (the Roll-Geske-Whaley model) and American puts (the Geske-Johnson model) on dividend paying stocks. It has the virtue of being internally consistent in that the same model can be used to value both calls and puts. In developing the DAM model, the paper clarifies the role of dividends and dividend policy in determining option values. It also produces significantly tightened boundary conditions for option values.     

CALL FOR PAPERS

Organized Uncertainty: Designing a World of Risk Management. Michael Power. Oxford University Press, 2007. xviii and 248pp. ISBN 978–0–9–925394–4. £24.99.

Intellectual Capital Reporting: Lessons from Hong Kong and Australia. J. Guthrie, R. Petty and F. Ricceri. The Institute of Chartered Accountants of Scotland, 2007, vii and 118pp. ISBN 978–1–904574–27–9. £15

The Routledge Companion to Fair Value and Financial Reporting. P. Walton (ed.). Routledge, 2007. xviii and 404 pp. ISBN 978–0–415–42356–4. £95.

UK Reporting of Intellectual Capital. Jeffrey Unerman, James Guthrie and Ludmila Striukova. ICAEW Centre for Business Performance, 2007. 68 pp. ISBN 978 1 84152 507 5. £20.