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secret2
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Joined: July 28th, 2010, 10:29 pm

FX and Rates Modeling

October 20th, 2011, 2:18 pm

Recently I have been reading Lipton's Mathematical Methods for Foreign ExchangeMathematical Methods for Foreign Exchange. Despite the archaic and uncommon notation, it talks about modeling FX and rates dynamics all at once, which is something I have not seen elsewhere. If we want to build such a model, we would at least need 3 factors (domestic and foreign rates and FX rate). I am wondering how FX option pricing is done in the industry, anyone can shed some light?Also, what do you think about Wystup's FX Options and Structured Products? There are so few reviews.
 
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ashkar
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Joined: October 17th, 2011, 9:25 am

FX and Rates Modeling

October 26th, 2011, 7:01 am

From what i've seen traders using on their desk:For short dated products its generally local vol/local stochastic vol with IR assumed constant.For long dated, its generally 3 factor model with IR-FX correlations . It may/may not have local/stoch vol for fx and sabr for IR. For pricing 3-factor can be slow so the traders choose according to their needs.
 
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DevonFangs
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Joined: November 9th, 2009, 1:49 pm

FX and Rates Modeling

October 26th, 2011, 11:38 am

QuoteOriginally posted by: ashkarFor long dated, its generally 3 factor model with IR-FX correlations . It may/may not have local/stoch vol for fx and sabr for IR. For pricing 3-factor can be slow so the traders choose according to their needs.dbl this.Wystup's book is not bad. If you google wystup filetype: pdf you can see some of his articles and get the flavor of the book.
Last edited by DevonFangs on October 25th, 2011, 10:00 pm, edited 1 time in total.
 
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DevonFangs
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FX and Rates Modeling

October 26th, 2011, 11:40 am

Ah, and the IR-FX correlation is really mysterious.
 
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MCarreira
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Joined: January 1st, 1970, 12:00 am

FX and Rates Modeling

October 26th, 2011, 5:46 pm

QuoteOriginally posted by: ashkarFrom what i've seen traders using on their desk:For short dated products its generally local vol/local stochastic vol with IR assumed constant.For long dated, its generally 3 factor model with IR-FX correlations . It may/may not have local/stoch vol for fx and sabr for IR. For pricing 3-factor can be slow so the traders choose according to their needs.Agree. Wystup's book doesn't go much deep into modeling.This book was supposed to cover that, but ...I like Iain Clark's book.