A Stochastic Volatility Model for Risk-Reversals in Foreign Exchange

International Journal of Theoretical and Applied Finance, Vol. 12, No. 6, pp. 877-899, 2009

20 Pages Posted: 1 Dec 2009 Last revised: 10 May 2011

Date Written: September 1, 2009

Abstract

It is a widely recognized fact that risk-reversals play a central role in the pricing of derivatives in foreign exchange markets. It is also known that the values of risk-reversals vary stochastically with time. In this paper we introduce a stochastic volatility model with jumps and local volatility, defined on a continuous time lattice, which provides a way of modeling this kind of risk using numerically stable and relatively efficient algorithms.

Keywords: Stochastic volatility, volatility surface dynamics, foreign exchange, risk-reversals, continuous-time Markov chains

Suggested Citation

Albanese, Claudio and Mijatovic, Aleksandar, A Stochastic Volatility Model for Risk-Reversals in Foreign Exchange (September 1, 2009). International Journal of Theoretical and Applied Finance, Vol. 12, No. 6, pp. 877-899, 2009, Available at SSRN: https://ssrn.com/abstract=1515570

Claudio Albanese

Global Valuation ( email )

9 Devonshire Sq.
London, London EC2M 4YF
United Kingdom

Aleksandar Mijatovic (Contact Author)

Imperial College London ( email )

Department of Mathematics
180 Queen's Gate
London, SW7 2AZ
United Kingdom

HOME PAGE: http://www3.imperial.ac.uk/people/a.mijatovic

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