The pricing of Quanto options under dynamic correlation

JOURNAL OF COMPUTATIONAL AND APPLIED MATHEMATICS

卷:275

Article

Teng, Long¹  Ehrhardt, Matthias¹  Guenther, Michael¹ 

[1] Berg Univ Wuppertal, Fachbereich Math & Nat Wissensch C, Lehrstuhl Angew Math & Numer Anal, D-42119 Wuppertal, Germany

关键词: Quanto options;    Dynamic correlation;    Hyperbolic tangent;    Black-Scholes equation;    Correlation risk;   

DOI  :  10.1016/j.cam.2014.07.017

来源: Elsevier

【 摘 要 】

The Quanto option is a cash-settled, cross-currency derivative in which the underlying asset has a payoff in one country, but the payoff is converted to another currency in which the option is settled. Thus, the correlation between the underlying asset and currency exchange rate plays an important role on pricing such options. Market observations give clear evidence that financial quantities are correlated in a strongly nonlinear way. In this work, instead of assuming a constant correlation, we develop a strategy for pricing the Quanto option under dynamic correlation in a closed formula, including the calibration to market data. By comparing the pricing and hedging strategy with and without dynamic correlation, we study the effect of dynamic correlation on the option pricing and hedging. The numerical results show that the prices of Quanta option under dynamic correlation can be better fitted to the market prices than using simply a constant correlation. (C) 2014 Elsevier B.V. All rights reserved.

【 授权许可】

Free