[R-SIG-Finance] [R-sig-finance] Domestic risk free rate in FX option
RON70
ron_michael70 at yahoo.com
Tue May 12 16:29:46 CEST 2009
"the price of EUROGBP is in US dollar" : from the specification given in CME
it is in GBP. Please see this :
http://www.cmegroup.com/trading/fx/fx/euro-fx-british-pound_contractSpecs_options.html
BearXu wrote:
>
> In my opinion, the risk free rate may still be the US risk free rate
> because
> the price of EUROGBP is in US dollar.
>
> But the derivative is changed in terms of its underlying, so whether the
> Model of EUROGBP is Brown Motion or not will affect your price formula
> much.
>
> 2009/5/12 Kris <kriskumar at earthlink.net>
>
>> To add my two cents to this.. Black-76 formula is really Black-scholes
>> with
>> the substitution F=S*exp((r-q)T) and is the formula used to price
>> options
>> in currency land on options on forwards in general. The black-76 formula
>> gives you a value in term pips so in the case of EURGBP the value that
>> comes
>> out of the formula is in GBP pips. In order to convert this as a % of EUR
>> notional you divide by Spot. If you are dealing with a GBP notional then
>> you
>> divide the result from the formula by strike to get this as a % of GBP
>> notional. Typical quoting convention is to quote as a % of BASE (EUR)
>> notional.
>>
>> In general it is useful to think of the equivalence to stocks when IBM is
>> quoted as 102$ it is really IBMUSD => the amount of USD you need for one
>> unit of IBM. So here IBM is the base or foreign ASSET and USD is the TERM
>> or
>> domestic asset in whose units the price is quoted. So when you price an
>> option on IBM the value you get is in term (USD) units
>>
>>
>> Hope this helps,
>>
>> Cheers
>> Krishna
>>
>> -----Original Message-----
>> >From: Mahesh Krishnan <heshriti at gmail.com>
>> >Sent: May 10, 2009 9:53 PM
>> >To: RON70 <ron_michael70 at yahoo.com>
>> >Cc: r-sig-finance at stat.math.ethz.ch
>> >Subject: Re: [R-SIG-Finance] [R-sig-finance] Domestic risk free rate in
>> FX
>> option
>> >
>> >Ron,
>> >
>> >Ultimately, currency options calculations depend on what you take as
>> >numeraire- the domestic currency, and what you take as the foreign
>> currency.
>> >In the case of CME, EUR/GBP is quoted as pounds per euro, i.e. the
>> domestic
>> >currency is pounds and foreign currency is euro.
>> >
>> >So if you were to price options on currencies using standard Merton's
>> stock
>> >formula, you use the risk free rate of UK as domestic, and risk free
>> rate
>> of
>> >Euro zone as your "dividend yield".
>> >
>> >To my knowledge, CME only has options on futures, not spot currency. And
>> if
>> >you are trying to price that, you basically plug in the risk free rate
>> of
>> UK
>> >in the futures-options model, and you get the option premium in pounds.
>> You
>> >need to verify that CME option price is quoted it in pounds, I beleive
>> it
>> >does.
>> >
>> >Mahesh
>> >
>> >
>> >
>> >On Wed, May 6, 2009 at 1:12 AM, RON70 <ron_michael70 at yahoo.com> wrote:
>> >
>> >>
>> >> In CME, option on forex is traded on EUR/GBP. If I want to price this
>> >> option
>> >> using some pricing formula then as Domestic risk free interest rate
>> what
>> >> should I take? Shouldn't risk free rate in UK be appropriate? I am
>> asking
>> >> this because as CME is in US, domestic currency is USD. Your
>> suggestion
>> >> appreciated.
>> >> --
>> >> View this message in context:
>> >>
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>> >>
>> >> _______________________________________________
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>> >
>> >
>> >
>> >--
>> >Mahesh Krishnan, Ph.D
>> >
>> > [[alternative HTML version deleted]]
>> >
>> >_______________________________________________
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