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Dynamic Hedging: Managing Vanilla And Exotic Op... !!BETTER!!

LV models work well for vanilla products pricing, but are unsuitable for capturing the smile dynamics, which is necessary for exotic path-dependent products such as autocallables. Reghai and Monciaud hit upon the idea of starting with the LV model to build the LSV model.

Dynamic Hedging: Managing Vanilla and Exotic Op...

That can be done by perturbing the parameters of the model to assess the impact of the smile dynamics on the P&L. In the case of LV and LSV, it turns out that a standard perturbation approach would cause undesirable effects when pricing vanilla products. Because LV is already a good pricer for vanilla products, additional terms that are supposed to be non-zero are likely to affect the calibration. Reghai and Monciaud found a novel solution to the problem. 041b061a72


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