Hanna Christelle Ho

Garman Kohlhagen Model

The Garman Kohlhagen Model is a pricing calculation that is used for European
options, those that can be exercised only on maturity date. It assesses European
options on spot foreign exchange. Variables that help find the price of an option on an
exchange rate include the spot price, the maturity date or the time it has before it
expires, the forward points, the domestic currency interest rate, and the implied
volatility. The assumptions made on the Black Scholes model are reduced in the
Garman Kohlhagen Model. The Garman Kohlhagen Model is different from the Black
Scholes Model. The German Kohlhagen Model is an extension of the Black Scholes
Model to handle one interest rate for each of the currency.


The assumptions include:
Options being exercised only on maturity date
Taxes, margins, or transaction costs are excluded
Domestic and foreign risk free interest rates are held constant
Underlying instrument has a price volatility also held constant
Lognormal distribution is observed in the price movements of the underlying
instrument.


C(S
0
, T, X) is the price of a call option where X is the strike price or exercise price that
expires in T years where S
0
serves as the actual spot exchange rate.



Where in


where



is the domestic currency value of a call option into the foreign currency.


P(S
0
, T, X) is the price of a put option where X is the strike price or exercise price that
expires in T years where S
0
serves as the actual spot exchange rate.



is the value of a put option.

Call Option Delta


Put Option Delta



Sources:

http://www.fincad.com/derivatives-resources/wiki/garman-kohlhagen-model.aspx

http://www.stat.unc.edu/faculty/cji/fys/2010/FX-options.pdf

http://flash.lakeheadu.ca/~pgreg/assignments/optionsn.pdf