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

Frédéric Bossens (), Gregory Rayee (), Nikos S. Skantzos () and Griselda Deelstra ()
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Griselda Deelstra: Department of Mathematics, Université Libre de Bruxelles, Brussels.

No 09-016.RS, Working Papers CEB from Université Libre de Bruxelles, Solvay Brussels School of Economics and Management, Centre Emile Bernheim (CEB)

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.

Keywords: Vanna-Volga; Foreign Exchange; exotic options; market conventions. (search for similar items in EconPapers)
Date: 2009-04
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Persistent link: http://EconPapers.repec.org/RePEc:sol:wpaper:09-016

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