FX Option pricing (negative domestic interest rate)

raags · January 27th, 2012, 12:50 am

Any idea how we deal with negative interest rates in FX Option pricing. I am talking about vanna volga pricing of a Up&In one touch option. Any research paper which discusses this?Thanks.

Chamito · March 13th, 2012, 4:44 pm

I would say that , as for other asset classes, pricing models tend to restrict interest rates to a positive value, as a rule of non arbitrage.here you would not consider "receiving a weak interest rate" and pay a huge interest rate, so as a non arbitrage the rates differential would be brought back to 0.Just food for thought, am not quite sure about that and cannot prove it/quote any professional for the matter