Vanna-Volga methods applied to FX derivatives : from theory to market practice
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
Cite
@article{arxiv.0904.1074,
title = {Vanna-Volga methods applied to FX derivatives : from theory to market practice},
author = {Frédéric Bossens and Grégory Rayée and Nikos S. Skantzos and Griselda Deelstra},
journal= {arXiv preprint arXiv:0904.1074},
year = {2010}
}