Efficient and Accurate Calibration to FX Market Skew with Fully Parameterized Local Volatility Model

Abstract

When trading American and Asian options in the FX derivatives market, banks must calculate prices using a complex mathematical model. It is often observed that different models produce varying prices for the same exotic option, which violates the non-arbitrage requirement of derivative risk management. To address this issue, we have studied a fully parameterized local volatility model for pricing American/Asian options. This model, when implemented using a grid or Monte-Carlo numerical method, can be efficiently and accurately calibrated to FX market skew volatilities. As a result, the model can provide reliable prices for exotic options during daily trading activities.