# Quanto options valuation

Pricing quanto derivatives involves modeling financial variables stocks, interest rates etc. In order to write the dynamics of the modeled financial variables under foreign currency pricing measure one has to apply Girsanov theorem leading to a drift term which depends on its volatility, the FX rate volatility FX rate between the pricing currency and the modeled variable currency and correlation between both.

This drift term leads to an adjustment in the pricing that is referred to as "quanto adjustment" and falls into the more general category of what is called in mathematical finance convexity adjustments. From Wikipedia, the free encyclopedia. Common types of quanto include: Quanto futures contracts , such as a futures contract on a European stock market index which is settled in US dollars.

Quanto options , in which the difference between the underlying and a fixed strike price is paid out in another currency. Quanto swaps , in which one counterparty pays a non-local interest rate to the other, but the notional amount is in local currency. The second party may be paying a fixed or floating rate.

For example, a swap in which the notional amount is denominated in Canadian dollars , but where the floating rate is set as USD LIBOR , would be considered a quanto swap. Pricing Quanto Derivatives [ edit ] Pricing quanto derivatives involves modeling financial variables stocks, interest rates etc. Retrieved from " https: Views Read Edit View history.

This page was last edited on 28 November , at By using this site, you agree to the Terms of Use and Privacy Policy. Quanto options have both the strike price and underlier denominated in the foreign currency. At exercise, the value of the option is calculated as the option's intrinsic value in the foreign currency, which is then converted to the domestic currency at the fixed exchange rate.

In these markets, a Quanto is a weather-contingent energy or commodity derivative. Weather contingent means that a payoff is triggered if some weather variable typically temperature, but also precipitation or any other weather variable crosses from above or from below a specified strike value. For the structure to be called Quanto, the payoff must depend on the market price of a publicly traded commodity. A typical example of a buyer of a Quanto is a retailer in a liberalized electricity market, with a customer base to which they deliver to a fixed contracted price.

The retailers do buy most of their electricity forward, but have to go and purchase from the expensive spot market whenever they need to deliver more than what they've planned to. This situation typically occurs if the weather is hotter colder than expected and a substantial number of households turn on the airconditioning heating. As electricity demand rises sharply in such a situation, spot prices spike while the revenue from the sales side remains constant.

Buying a quanto allows the retailer to hedge against that risk. Pricing quanto derivatives involves modeling financial variables stocks, interest rates etc. In order to write the dynamics of the modeled financial variables under foreign currency pricing measure one has to apply Girsanov theorem leading to a drift term which depends on its volatility, the FX rate volatility FX rate between the pricing currency and the modeled variable currency and correlation between both.

This drift term leads to an adjustment in the pricing that is referred to as "quanto adjustment" and falls into the more general category of what is called in mathematical finance convexity adjustments.

From Wikipedia, the free encyclopedia. Common types of quanto include: