Mixed Local Volatility Model Boosts Distribution of Exotics

As a market maker for FX Derivatives, and especially flow products on a single dealer platform, one needs the best trade-off between precision and speed in one’s exotics model. A Mixed Local Volatility (MLV) model is a simplified, yet powerful version of the full-fledged Stochastic Local Volatility (SLV) model. It ignores correlation between spot and volatility (which is common in FX); the skew is generated exclusively from local volatility, and the stochastic volatility process is simplified into a discrete set of volatility states. The key features include:

· MLV is more than 10 times faster for calibration and pricing than SLV.

· It allows flexible calibration to term-structure of Double-No-Touch (DNT) contracts.

· It is arguably the market standard for pricing a large range of 1st generation exotics.

I compare the MLV model with SLV, traditional Vanna-Volga approaches and discuss model risk.

Professor Uwe Wystup, Founder and Managing Director of MathFinance AG, Professor of Foreign Exchange Derivatives at University of Antwerp

Uwe Wystup (uwe.wystup@mathfinance.com) is the founder and Managing Director of MathFinance AG, an independent consulting and software company that specializes in FX derivatives pricing. Uwe got his PhD in Mathematical Finance with Steven E. Shreve at Carnegie Mellon University, he is the author of two books “Foreign Exchange Risk” and “FX Options and Structured Products”, writes the FX column for Wilmott magazine and published in many academic journals. Uwe is professor of Foreign Exchange Derivatives at University of Antwerp, and honorary professor of Quantitative Finance at Frankfurt School of Finance & Management, certified public expert for currency markets at Frankfurt’s Chamber of Commerce and the Expert Witness Institute. Ever since he started his FX options front-office role at Citibank in 1992 he has been a great fan of FX markets.

Registration deadline: Mar 2, 2021

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Mixed Local Volatility Model Boosts Distribution of Exotics

Professor Uwe Wystup, Founder and Managing Director of MathFinance AG, Professor of Foreign Exchange Derivatives at University of Antwerp

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