fx volatility smile construction
The attenuation factors are of a different from for the Vanna or the Volga of an instrument. This is because for barrier values close to the spot they behave differently: the Vanna becomes large while, on the contrary, the Volga becomes small. Hence the attenuation factors take the form:.
Both of these quantities offer the desirable property that they vanish close to a barrier. For example, for a single barrier option we have.
Similarly, for options with two barriers the survival probability is given through the undiscounted value of a double-no-touch option. The first exit time FET is the minimum between: i the time in the future when the spot is expected to exit a barrier zone before maturity, and ii maturity, if the spot has not hit any of the barrier levels up to maturity.
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Vanna-Vega-Volga is a cute way of interpolating the fx implied volatility surface. The problem is that the vols coming from that interpolation do not match the interbank quoted volatilities, you can't match the 10 delta wings without some weird contortions and using that methodology for first generation exotics results in the incorrect market price.
To be fair the same is true for Heston but it has the added benefit of being the base model for a lot of the more sophisticated models you do need to match first generation fx exotics. Sign up to join this community.
FX options and smile risk (eBook, ) []
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Learn more. Asked 1 month ago. Active 30 days ago. Viewed times. In summary: What are the disadvantages of the Vanna-Volga method?
The Main Risks of an FX Options Portfolio, Some Untimely Considerations of an Option Trader
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Als Gutschein. The FX options market represents one of the most liquid and strongly competitive markets in the world, and features many technical subtleties that can seriously harm the uninformed and unaware trader. Striking a balance between mathematical rigour and market practice and written by experienced practitioner Antonio Castagna, the book shows readers how to correctly build an entire volatility surface from the market prices of the main structures.