VANNA-VOLGA METHODS APPLIED TO FX DERIVATIVES: FROM THEORY TO MARKET PRACTICE

Frédéric Bossens (), Grégory Rayée, Nikos S. Skantzos () and Griselda Deelstra ()
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Frédéric Bossens: Termeulenstraat 86A, Sint-Genesius-Rode, B-1640, Belgium
Nikos S. Skantzos: Ijzerenmolenstraat 113, Leuven B-3001, Belgium
Griselda Deelstra: Department of Mathematics, Université Libre de Bruxelles, Boulevard du Triomphe, CP 210, Brussels 1050, Belgium

International Journal of Theoretical and Applied Finance (IJTAF), 2010, vol. 13, issue 08, 1293-1324

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: 2010
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Citations: View citations in EconPapers (7)

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DOI: 10.1142/S0219024910006212

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