Abstract

We introduce a tractable multicurrency model with stochastic volatility and correlated stochastic interest rates that takes into account the smile in the foreign exchange (FX) market and the evolution of yield curves. The pricing of vanilla options on FX rates can be efficiently performed through the FFT methodology thanks to the affine property of the model. Our framework is also able to describe many nontrivial links between FX rates and interest rates: a calibration exercise highlights the ability of the model to simultaneously fit FX implied volatilities while being coherent with interest rate products.

Keywords

  1. FX options
  2. long-dated FX
  3. Wishart process

MSC codes

  1. 91G20
  2. 91G30
  3. 60H30

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Published In

cover image SIAM Journal on Financial Mathematics
SIAM Journal on Financial Mathematics
Pages: 493 - 531
ISSN (online): 1945-497X

History

Submitted: 29 May 2013
Accepted: 6 May 2014
Published online: 28 August 2014

Keywords

  1. FX options
  2. long-dated FX
  3. Wishart process

MSC codes

  1. 91G20
  2. 91G30
  3. 60H30

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