Vanna-Volga Methods Applied to FX Derivatives: From Theory to Market Practice

Bossens, Frédéric; Rayée, Grégory; Skantzos, N. S.; Deelstra, Griselda

doi:10.2139/ssrn.1380063

Cited by 13 publications

(8 citation statements)

References 14 publications

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“…Although some researchers have used a linear smile (Mixon, 2009), a quadratic function is the lowest order smile that can capture the two most important departures from lognormality observed in financial markets-fatter tails and skewness. A quadratic smile also allows for higher order Greeks like Vanna and Volga that are known to be important in option pricing models (Bossens, Rayée, Skantzos, & Deelstra, 2010;Castagna & Mercurio, 2007). A quadratic smile is also extensively used in practice in the form of straddle and risk-reversal prices (Malz, 1997).…”

Section: Estimating Smilementioning

confidence: 99%

Indian equity options: Smile, risk premiums, and efficiency

Jain

Varma

Agarwalla

2018

Journal of Futures Markets

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We study the pricing of equity options in India which is one of the world's largest options markets. Our findings are supportive of market efficiency: A parsimonious smile‐adjusted Black model fits option prices well, and the implied volatility (IV) has incremental predictive power for future volatility. However, the risk premium embedded in IV for Single Stock Options appears to be higher than in other markets. The study suggests that even a very liquid market with substantial participation of global institutional investors can have structural features that lead to systematic departures from the behavior of a fully rational market while being “microefficient.”

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Section: Estimating Smilementioning

confidence: 99%

Indian equity options: Smile, risk premiums, and efficiency

Jain

Varma

Agarwalla

2018

Journal of Futures Markets

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“…14 More details about the Vanna-Volga method can be found in, e. g., CASTAGNA and MERCURIO (2005), CASTAGNA and MERCURIO (2007), WYSTUP (2010b) andBOSSENS et al (2010).…”

Section: Datamentioning

confidence: 99%

The Costs of Implementing a Unilateral One-Sided Exchange Rate Target Zone

Hertrich¹

2016

Review of Economics

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In the aftermath of the recent financial crisis, the central banks of small open economies such as the Swiss National Bank (SNB) implemented a unilateral one-sided exchange rate target zone vis-à-vis the euro currency to counteract deflationary pressures. Recently, the SNB abandoned its minimum exchange rate regime, arguing that after having analyzed the costs and benefits of this non-standard exchange rate policy measure, it was no longer sustainable. This paper proposes a model that allows central banks and policymakers to estimate ex-ante the costs of implementing and maintaining a unilateral onesided target zone (in terms of the expected size of foreign-exchange interventions) and to monitor these costs during the period in which it is enforced. The model also offers central banks a tool to identify the right timing for the discontinuation of a minimum exchange rate regime. An empirical application to the Swiss case shows the ex-ante estimated size of these costs and reveals that these costs might have been substantial without the abandonment of the minimum exchange rate regime, which accords with the official statements of the SNB.

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“…In this case, the customers have to employ the smile construction procedure. Related sources covering this subject can be found in Bossens et al (2009), Castagna (2010), Clark (2010). Unlike in other markets, the FX smile is given implicitly as a set of restrictions implied by market instruments.…”

Section: Construction Of Implied Volatility Smilesmentioning

confidence: 99%

“…In Bossens et al (2009), the authors use a first order Taylor expansion around the at-the-money volatility to show that the market strangle can be represented as a vega weighted sum of smile consistent volatilities. In opposite to the derivation in Bossens et al (2009), we will expand around the market strangle volatility s 25−S−M which yields 4 :…”

Section: Market Strangle As An Average Of Smile Volatilitiesmentioning

confidence: 99%

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FX Volatility Smile Construction

Reiswich¹,

Wystup²

2012

Wilmott

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The foreign exchange options market is one of the largest and most liquid OTC derivative markets in the world. Surprisingly, very little is known in the academic literature about the construction of the most important object in this market: The implied volatility smile. The smile construction procedure and the volatility quoting mechanisms are FX specific and differ significantly from other markets. We give a brief overview of these quoting mechanisms and provide a comprehensive introduction to the resulting smile construction problem. Furthermore, we provide a new formula which can be used for an efficient and robust FX smile construction. TECHNICAL PAPER^Ŵilmott magazine 59The introduced deltas can be stated as Black-Scholes type of formulas for puts and calls. For example, the premium-adjusted spot delta can be deduced fromwhere D S is the standard Black-Scholes delta. The resulting formulas are summarized in Table 2. At-the-MoneyThe at-the-money definition is not as obvious as one might think. If a volatility s ATM is quoted, and no corresponding strike, one has to identify which at-the-money quotation is used. Some common at-the-money definitions areIn addition to that, all notions of ATM involving delta will have sub-categories depending on which delta convention is used. The at-the-money spot quotation is well known. ATM-forward is very common for currency pairs with a large interest rate differential (emerging markets) or a large time to maturity. Choosing the strike in the ATM-delta-neutral sense ensures that a straddle with this strike has a zero delta (where delta has to be specified). This convention is considered as the default ATM notion for short-dated FX options. The formulas for different at-the-money strikes can be found in

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Vanna-Volga Methods Applied to FX Derivatives: From Theory to Market Practice

Cited by 13 publications

References 14 publications

Indian equity options: Smile, risk premiums, and efficiency

Indian equity options: Smile, risk premiums, and efficiency

The Costs of Implementing a Unilateral One-Sided Exchange Rate Target Zone

FX Volatility Smile Construction

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