Expansion formulas for European quanto options in a local volatility FX-LIBOR model

DOI10.1142/S0219024918500176zbMATH Open1395.91448arXiv1801.01205OpenAlexW2963943374WikidataQ130065245 ScholiaQ130065245MaRDI QIDQ4634643FDOQ4634643

Authors: Julien Hok, Philip Ngare, Antonis Papapantoleon 

Publication date: 11 April 2018

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

Abstract: We develop an expansion approach for the pricing of European quanto options written on LIBOR rates (of a foreign currency). We derive the dynamics of the system of foreign LIBOR rates under the domestic forward measure and then consider the price of the quanto option. In order to take the skew/smile effect observed in fixed income and FX markets into account, we consider local volatility models for both the LIBOR and the FX rate. Because of the structure of the local volatility function, a closed form solution for quanto option prices does not exist. Using expansions around a proxy related to log-normal dynamics, we derive approximation formulas of Black--Scholes type for the price, that have the benefit of giving very rapid numerical procedures. Our expansion formulas have the major advantage that they allow for an accurate estimation of the error, using Malliavin calculus, which is directly related to the maturity of the option, the payoff, and the level and curvature of the local volatility function. These expansions also illustrate the impact of the quanto drift adjustment, while the numerical experiments show an excellent accuracy.

Full work available at URL: https://arxiv.org/abs/1801.01205

Recommendations

• Local volatility for quanto option prices with stochastic interest rates
• Local volatilities for quanto option prices with various types of payoffs
• Expansion formulas for European options in a local volatility model
• Valuation on Quanto options in jump-diffusion model with stochastic volatility
• Pricing of quanto option under the Hull and White stochastic volatility model

zbMATH Keywords

expansion formulaconvexity adjustmentanalytical approximations, Malliavin calculusEuropean quanto derivativeslocal volatility FX-LIBOR modelvolatility skew/smile

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Stochastic calculus of variations and the Malliavin calculus (60H07)

Cites Work

• Title not available (Why is that?)
• Title not available (Why is that?)
• Martingale methods in financial modelling.
• Interest rate models -- theory and practice. With smile, inflation and credit
• Volatility skews and extensions of the Libor market model
• Title not available (Why is that?)
• An asymptotic expansion approach to pricing financial contingent claims
• Time dependent Heston model
• Title not available (Why is that?)
• Title not available (Why is that?)
• Analytical formulas for a local volatility model with stochastic rates
• Analytical approximation of the transition density in a local volatility model
• Asymptotics and calibration of local volatility models
• Stochastic Implied Trees: Arbitrage Pricing with Stochastic Term and Strike Structure of Volatility
• Applications of the asymptotic expansion approach based on Malliavin-Watanabe calculus in financial problems
• Large deviations and asymptotic methods in finance
• Expansion formulas for European options in a local volatility model
• Equivalent Black volatilities
• Approximations for Asian options in local volatility models
• Smart expansion and fast calibration for jump diffusions
• Weak approximation of averaged diffusion processes
• A multicurrency extension of the lognormal interest rate market models
• Stochastic Approximation Finite Element Method: Analytical Formulas for Multidimensional Diffusion Process
• Forward implied volatility expansion in time-dependent local volatility models
• EXPANSION FORMULAS FOR BIVARIATE PAYOFFS WITH APPLICATION TO BEST-OF OPTIONS ON EQUITY AND INFLATION

Cited In (2)

• Speeding up the Euler scheme for killed diffusions
• Calibration of local volatility model with stochastic interest rates by efficient numerical PDE methods

This page was built for publication: Expansion formulas for European quanto options in a local volatility FX-LIBOR model

Report a bug (only for logged in users!)Click here to report a bug for this page (MaRDI item Q4634643)