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

28 Pages Posted: 15 Apr 2009 Last revised: 28 Apr 2010

See all articles by Frederic Bossens

Frederic Bossens

affiliation not provided to SSRN

Grégory Rayée

Université Libre de Bruxelles (ULB)

Nikos S. Skantzos

affiliation not provided to SSRN

Griselda Deelstra

Université Libre de Bruxelles (ULB)

Date Written: April 27, 2010

Abstract

We study Vanna-Volga methods which are used to price first generation exotic options in the Foreign Exchange market. They are based on a rescaling of the correction to the Black-Scholes price through the so-called 'probability of survival' and the 'expected first exit time'. Since the methods rely heavily on the appropriate treatment of market data we also provide a summary of the relevant conventions. We offer a justification of the core technique for the case of vanilla options and show how to adapt it to the pricing of exotic options. Our results are compared to a large collection of indicative market prices and to more sophisticated models. Finally we propose a simple calibration method based on one-touch prices that allows the Vanna-Volga results to be in line with our pool of market data.

Keywords: Vanna-Volga, Foreign Exchange, exotic options, market conventions

JEL Classification: C00

Suggested Citation

Bossens, Frederic and Rayée, Grégory and Skantzos, Nikos S. and Deelstra, Griselda, Vanna-Volga Methods Applied to FX Derivatives: From Theory to Market Practice (April 27, 2010). Available at SSRN: https://ssrn.com/abstract=1380063 or http://dx.doi.org/10.2139/ssrn.1380063

Frederic Bossens (Contact Author)

affiliation not provided to SSRN ( email )

Grégory Rayée

Université Libre de Bruxelles (ULB) ( email )

CP 114/04 Av FD Roosevelt 50
Brussels, 1050
Belgium

Nikos S. Skantzos

affiliation not provided to SSRN ( email )

Griselda Deelstra

Université Libre de Bruxelles (ULB) ( email )

Boulevard du Triomphe, CP210
Brussels, Brussels 1050
Belgium

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