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

Fr\'ed\'eric Bossens, Gr\'egory Ray\'ee, Nikos S. Skantzos and Griselda Deelstra
Authors registered in the RePEc Author Service: Grégory Rayée

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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.

Date: 2009-04, Revised 2010-05
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Citations: View citations in EconPapers (11)

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