A Multi-Currency Model with FX Volatility Skew
25 Pages Posted: 5 Apr 2005
Date Written: February 7, 2005
The paper develops a multi-currency model with FX skew for power-reverse dual-currency (PRDC) swaps, with a particular emphasis on model calibration to FX options across different maturities and strikes. New theoretical results on locally-optimal Markovian projections are obtained. When combined with powerful skew averaging techniques, a fast and robust calibration method is developed. The impact of the FX skew on cancellable and knockout PRDC swaps is analyzed.
Keywords: FX hybrids, Power-reverse dual-currency notes, PRDC, FX volatility skew, three-factor model, multi-currency model
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