Quanto Pre-washing for Jump Diffusion Models

Hoi Ying Wong and Ka Yung Lau
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Hoi Ying Wong: Department of Statistics, The Chinese University of Hong Kong, Hong Kong
Ka Yung Lau: Department of Treasury Risk, Fubon Bank Hong Kong, Hong Kong

Chapter 12 in Recent Advances in Financial Engineering, 2009, pp 219-230 from World Scientific Publishing Co. Pte. Ltd.

Abstract: AbstractA quanto option is a derivatives security whose value depends on an exchange rate (domestic over foreign) and a foreign asset. Usually, the stochastic process of the exchange rate is given under the domestic risk-neutral measure whereas that of the foreign equity is defined under the foreign risk-neutral measure. As quanto options are quoted in the domestic currency world, the valuation requires the quanto pre-washing procedure which identifies the process of the foreign asset under the domestic risk-neutral measure and that of the domestic equivalent asset (the product of the exchange rate and the foreign asset value) under the domestic risk-neutral measure. This paper investigates the quanto pre-washing for the exchange rate and the foreign asset both following jump diffusion models with correlated Brownian motion component, common jumps and possibly dependent jump sizes. The use of the results is illustrated with the Merton jump diffusion model.

Keywords: Financial Engineering; Mathematical Finance; Real Options; Credit Risk; Option Pricing; Transaction Cost; Market Microstructure (search for similar items in EconPapers)
Date: 2009
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