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Quanto forwards and vol skew
Posted: May 10th, 2006, 4:48 pm
by CMPT
How does one choose vol1 and vol2 for the rho*vol1*vol2 term in quanto forward when there is vol skew? Those corresponding to atmf's?Thanks
Quanto forwards and vol skew
Posted: May 17th, 2006, 11:04 pm
by sunya
If skew/smile is strong on the underlying or the base. Effect may be big because the drift adjustment is then spot dependent through the vols, adding some convexity. This additionnal quanto effect can be dozens of % as large as the BS quanto adjustment effect !
Quanto forwards and vol skew
Posted: May 19th, 2006, 3:03 pm
by Muzzy
You may find it hard to realise whatever number you come up with, since the chances are you will be just delta hedging the position, perhaps with an ATM option hedge, or perhaps not. Your final P&L will likely be determined by what actaully happens, rather than the price of options today.
Quanto forwards and vol skew
Posted: May 20th, 2006, 10:03 am
by sunya
In theory you would hedge with 3 spots + 3 smiles. Now I agree that if you had only one option you would "just delta hedge + ATM".First, since vol and skew are very correlated with spot, the delta you'll have using a better model should be better.Moreover if your desk is big enough the quanto options will be booked in the correlation book (eg. with baskets). So in fact you may very well be hedging with everything mentionned above. So a slightly more advanced model will give you slightly better greeks, which should mean a better PnL explain.Well at least that is what I say to myself in the morning when i want to convince myself I am not just a smokescreen for RiskManagment.