A STOCHASTIC VOLATILITY MODEL FOR RISK-REVERSALS IN FOREIGN EXCHANGE

Claudio Albanese and Aleksandar Mijatović ()
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Aleksandar Mijatović: Department of Mathematics, Imperial College, London, United Kingdom

International Journal of Theoretical and Applied Finance (IJTAF), 2009, vol. 12, issue 06, 877-899

Abstract: It is a widely recognized fact that risk-reversals play a central role in the pricing of derivatives in foreign exchange markets. It is also known that the values of risk-reversals vary stochastically with time. In this paper we introduce a stochastic volatility model with jumps and local volatility, defined on a continuous time lattice, which provides a way of modeling this kind of risk using numerically stable and relatively efficient algorithms.

Keywords: Stochastic volatility; volatility surface dynamics; foreign exchange; risk-reversals; continuous-time Markov chains (search for similar items in EconPapers)
Date: 2009
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DOI: 10.1142/S0219024909005506

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