An Evaluation of an Option Pricing Model for the Colombian Peso-US Dollar Exchange Market

In this study, we develop and evaluate a foreign currency option pricing model for the Colombian peso/US dollar exchange market by comparing the Garman-Kohlhagen and Heston models. We analyze data for Call and Put options obtained from the Bloomberg monitor for the period between May 5, 2018, and December 31, 2019. To calibrate the Heston model, we employ various variables and optimization techniques to estimate the most accurate values for these variables, ultimately deriving the model’s closed-form solution. Our findings indicate that the Heston model produces better results than the Garman-Kohlhagen model. Specifically, the Call option prices estimated by Heston are very close to actual market values, while the Garman-Kohlhagen model shows significant discrepancies compared to market prices. We also conducted a normality test which revealed that stochastic volatility models, such as Heston’s, provide more accurate predictions for option prices in the Colombian peso/US dollar market compared to the Garman-Kohlhagen model.