FX Options in Target Zone

Carr, Peter; Kakushadze, Zura

doi:10.2139/ssrn.2699250

Cited by 2 publications

(1 citation statement)

References 93 publications

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“…Research literature on pegged market in view of option pricing is particularly scarce, we refer to [9] for an overview and discussion about it. From the quantitative viewpoint however, the following works address the problem of option pricing for bounded diffusions in view of pegged markets, starting with Ingersoll [20] and then [5,6,26]. These models while self contained for pricing within a band, do not apply for real data calibration on pegged markets as they do not allow for strikes outside of the band.…”

Section: Introductionmentioning

confidence: 99%

Pricing and Hedging Performance on Pegged FX Markets Based on a Regime Switching Model

Drapeau¹,

Zhang²

2019

Preprint

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This paper investigates the hedging performance of pegged foreign exchange market in a regime switching (RS) model introduced in Drapeau et al. [9]. We compare two prices, an exact solution and first order approximation and provide the bounds for the error. We provide exact RS delta, approximated RS delta as well as mean variance hedging strategies for this specific model and compare their performance. To improve the efficiency of the pricing and calibration procedure, the Fourier approach of this regime-switching model is developed in our work. It turns out that: 1 -the calibration of the volatility surface with this regime switching model outperforms on real data the classical SABR model; 2 -the Fourier approach is significantly faster than the direct approach; 3 -in terms of hedging, the approximated RS delta hedge is a viable alternative to the exact RS delta hedge while significantly faster.

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