Vanna-Volga methods applied to FX derivatives: from theory to market practice

DOI10.1142/S0219024910006212MaRDI QIDQ3067166zbMATH OpenOpenAlexFDO

Authors Frédéric Bossens, Grégory Rayée, Nikos S. Skantzos, Griselda Deelstra

Publication date 20 January 2011

Published in International Journal of Theoretical and Applied Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/0904.1074

zbMATH Keywords

foreign exchangeexotic optionsmarket conventionsVanna-Volga

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Statistical methods; risk measures (91G70)

Abstract: We study Vanna-Volga methods which are used to price first generation exotic options in the Foreign Exchange market. They are based on a rescaling of the correction to the Black-Scholes price through the so-called `probability of survival' and the `expected first exit time'. Since the methods rely heavily on the appropriate treatment of market data we also provide a summary of the relevant conventions. We offer a justification of the core technique for the case of vanilla options and show how to adapt it to the pricing of exotic options. Our results are compared to a large collection of indicative market prices and to more sophisticated models. Finally we propose a simple calibration method based on one-touch prices that allows the Vanna-Volga results to be in line with our pool of market data.

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Cites work

• scientific article; zbMATH DE number 1869203 (Why is no real title available?)
• A closed-form solution for options with stochastic volatility with applications to bond and currency options
• Interest rate models -- theory and practice. With smile, inflation and credit
• Paul Wilmott on quantitative finance. 3 Vols. With CD-ROM
• The pricing of options and corporate liabilities

Cited in

(2)

• Multivariate FX models with jumps: triangles, quantos and implied correlation
• A multivariate stochastic volatility model with applications in the foreign exchange market

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