The vanna - volga method for derivatives pricing
AbstractThis Master thesis highlights some basic features and applications of the vanna-volga method and its accuracy when pricing plain vanillas and simple barrier options. In the paper we derive formulas for premiums of vanilla FX options using two versions of the vanna-volga method – the exact vanna-volga method and the simplified vanna-volga method. We review a very common vanna-volga variation used to price the first-generation exotics and the application of the vanna-volga method to construct the implied volatility surface. Furthermore, we briefly discuss a popular stochastic volatility model that aims to take the smile effect into account – the Heston model. Its accuracy and efficiency is further compared with that of the vanna-volga method. In the part of the thesis, which is devoted to calibration results, we compare the results obtained by the exact vanna-volga method, the simplified vanna-volga method and the Heston model. We also investigate the accuracy of the vanna-volga method applied to barrier options. All the plots and graphs in this thesis were produced by programs implemented by the author in MATLAB. These programs are available on request.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 36127.
Date of creation: Jul 2011
Date of revision:
vanna- volga method; implied volatility; volatility smile; Heston model;
Find related papers by JEL classification:
- C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
- C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-02-08 (All new papers)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Agnieszka Janek & Tino Kluge & Rafał Weron & Uwe Wystup, 2010.
"FX Smile in the Heston Model,"
SFB 649 Discussion Papers
SFB649DP2010-047, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
- Agnieszka Janek & Tino Kluge & Rafal Weron & Uwe Wystup, 2010. "FX Smile in the Heston Model," HSC Research Reports HSC/10/02, Hugo Steinhaus Center, Wroclaw University of Technology.
- Agnieszka Janek & Tino Kluge & Rafal Weron & Uwe Wystup, 2010. "FX Smile in the Heston Model," Papers 1010.1617, arXiv.org.
- Janek, Agnieszka & Kluge, Tino & Weron, Rafal & Wystup, Uwe, 2010. "FX Smile in the Heston Model," MPRA Paper 25491, University Library of Munich, Germany.
- Garman, Mark B. & Kohlhagen, Steven W., 1983. "Foreign currency option values," Journal of International Money and Finance, Elsevier, vol. 2(3), pages 231-237, December.
- Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
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