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
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: Suggested Citation