Farkas, Márton and Nagy, Viktor
(Citibank)
Models for pricing quanto products
in finance
Quantos are cross-currency derivatives that have an underlier denominated in one “foreign” currency (USD for USA stocks), but settles in another “domestic” currency (Hungarian Forints). Quantos are popular choice for investors, because then can eliminate cross-currency risk (buying stock futures in the USA market on Google, for instance, but looking for a payout in Hungarian Forints). We will illustrate modelling approaches used in practice to price cross-currency derivatives via the following examples:
· Quanto equity forward: A Hungarian investor can choose to buy stock forwards on the USA market with a fixed dollar to forint exchange rate, set at the inception of the contract (thus eliminating exchange rate risk entirely).
· Quanto CDS: An investor can buy protection (a kind of life insurance) against bankruptcy of a USA corporation, but reimbursement for the losses will come in Euros rather than USA dollars.
The increased volatility of
cross-currency markets has put some of the early models under considerable
pressure and the generic underlying assumptions can no longer be made. We will
discuss some of these challenges and outline potential resolutions.
Date: Sep. 29, Tuesday 4:15pm
Place: BME, Building „Q”, Room QBF13