Bollen, NPBRasiel, E2010-03-092003-02-010261-5606https://hdl.handle.net/10161/1967We compare option valuation models based on regime-switching, GARCH, and jump-diffusion processes to a standard "smile" model, in which Black and Scholes (1973) implied volatilities are allowed to vary across strike prices. The regime-switching, GARCH, and jump-diffusion models provide significant improvement over a fixed smile model in fitting GBP and JPY option prices both in-sample and out-of-sample. The jump-diffusion model achieves the tightest fit. A time-varying smile model, however, provides hedging performance that is comparable to the other models for the GBP options. This result suggests that standard option valuation techniques may provide a reasonable basis for trading and hedging strategies. © 2003 Elsevier Science Ltd. All rights reserved.application/pdfen-USJournal article