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A Stochastic Volatility Model For Risk-Reversals In Foreign Exchange

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  • CLAUDIO ALBANESE

    (Department of Mathematics, King's College London, Strand, London, WC2R2LS, United Kingdom)

  • ALEKSANDAR MIJATOVIĆ

    (Department of Mathematics, Imperial College, London, United Kingdom)

Abstract

It is a widely recognized fact that risk-reversals play a central role in the pricing of derivatives in foreign exchange markets. It is also known that the values of risk-reversals vary stochastically with time. In this paper we introduce a stochastic volatility model with jumps and local volatility, defined on a continuous time lattice, which provides a way of modeling this kind of risk using numerically stable and relatively efficient algorithms.

Suggested Citation

  • Claudio Albanese & Aleksandar Mijatović, 2009. "A Stochastic Volatility Model For Risk-Reversals In Foreign Exchange," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 12(06), pages 877-899.
    • Handle: RePEc:wsi:ijtafx:v:12:y:2009:i:06:n:s0219024909005506
    DOI: 10.1142/S0219024909005506
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    References listed on IDEAS

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    1. Alexander Lipton, 2001. "Mathematical Methods for Foreign Exchange:A Financial Engineer's Approach," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 4694, February.
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