Pricing currency derivatives under the benchmark approach

Baldeaux, J; Grasselli, M; Platen, E

Pricing currency derivatives under the benchmark approach

Baldeaux, J Grasselli, M Platen, E

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Publication Type:: Journal Article
Citation:: Journal of Banking and Finance, 2015, 53 pp. 34 - 48
Issue Date:: 2015-04-01

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Field	Value	Language
dc.contributor.author	Baldeaux, J	en_US
dc.contributor.author	Grasselli, M	en_US
dc.contributor.author	Platen, E https://orcid.org/0000-0003-4595-3123	en_US
dc.date.available	2020-05-25T19:17:42Z
dc.date.issued	2015-04-01	en_US
dc.identifier.citation	Journal of Banking and Finance, 2015, 53 pp. 34 - 48	en_US
dc.identifier.issn	0378-4266	en_US
dc.identifier.uri	http://hdl.handle.net/10453/33085
dc.description.abstract	© 2014 Elsevier B.V. This paper considers the realistic modelling of derivative contracts on exchange rates. We propose a stochastic volatility model that recovers not only the typically observed implied volatility smiles and skews for short dated vanilla foreign exchange options but allows one also to price payoffs in foreign currencies, lower than possible under classical risk neutral pricing, in particular, for long dated derivatives. The main reason for this important feature is the strict supermartingale property of benchmarked savings accounts under the real world probability measure, which the calibrated parameters identify under the proposed model. Using a real dataset on vanilla option quotes, we calibrate our model on a triangle of currencies and find that the risk neutral approach fails for the calibrated model, while the benchmark approach still works.	en_US
dc.relation.ispartof	Journal of Banking and Finance	en_US
dc.relation.isbasedon	10.1016/j.jbankfin.2014.11.018	en_US
dc.subject.classification	Finance	en_US
dc.title	Pricing currency derivatives under the benchmark approach	en_US
dc.type	Journal Article
utslib.citation.volume	53	en_US
utslib.for	150201 Finance	en_US
utslib.for	0102 Applied Mathematics	en_US
utslib.for	1401 Economic Theory	en_US
utslib.for	1502 Banking, Finance and Investment	en_US
pubs.embargo.period	Not known	en_US
pubs.organisational-group	/University of Technology Sydney
pubs.organisational-group	/University of Technology Sydney/Faculty of Business
pubs.organisational-group	/University of Technology Sydney/Faculty of Science
pubs.organisational-group	/University of Technology Sydney/Faculty of Science/School of Mathematical and Physical Sciences
pubs.organisational-group	/University of Technology Sydney/Strength - QFRC - Quantitative Finance Research Centre
utslib.copyright.status	open_access
pubs.publication-status	Published	en_US
pubs.volume	53	en_US

Abstract:

© 2014 Elsevier B.V. This paper considers the realistic modelling of derivative contracts on exchange rates. We propose a stochastic volatility model that recovers not only the typically observed implied volatility smiles and skews for short dated vanilla foreign exchange options but allows one also to price payoffs in foreign currencies, lower than possible under classical risk neutral pricing, in particular, for long dated derivatives. The main reason for this important feature is the strict supermartingale property of benchmarked savings accounts under the real world probability measure, which the calibrated parameters identify under the proposed model. Using a real dataset on vanilla option quotes, we calibrate our model on a triangle of currencies and find that the risk neutral approach fails for the calibrated model, while the benchmark approach still works.

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http://hdl.handle.net/10453/33085