ABSTRACT
In classical arbitrage pricing of options the specification of a statistical distribution that models the price changes of the underlying security plays a fundamental role. The basic currency option valuation formulas, such as those of Garman and Kohlhagen (1983) and Grabbe (1983), assume that the exchange rate, like the stock price in the Black and Scholes (1973) article, follows an Ito process. The stochastic part of the exchange rate is assumed to follow a geometric Brownian motion, which implies a lognormal distribution of exchange rate changes.
