To hedge investments made in different economies, investors make use of cross-currency derivatives to manage risks associated with fluctuations of exchange rates. In this paper, we set forth the discussion of extending the random field LIBOR market model (RFLMM) to the cross-currency setting. We assume that forward LIBOR rates of the domestics and foreign economies are lognormal and derive an approximate closed-form pricing solution for a Quanto cap written on a foreign forward LIBOR rate . Further, we derive an exact pricing formula for an option written on the spot exchange rate between the domestic and a foreign economy .
We develop an arbitrage-free random field LIBOR market model to price cross-currency derivatives. The uncertainty of the forward LIBOR rates of our cross-currency model is driven by a two time parameter random field instead of a finite dimensional Brownian motion. To demonstrate the applications of this model, we develop an approximate closed-form pricing formula for Quanto caps and cross-currency swaps . Further, we derive an exact pricing formula for an exchange rate option in the random field setting .
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To hedge investments made in different economies, investors make use of cross-currency derivatives to manage risks associated with fluctuations of exchange rates. In this paper, we set forth the discussion of extending the
We develop an arbitrage-free
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(RFLMM) to the
to price
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setting. We assume that
derivatives. The uncertainty of the
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the domestics and foreign economies are lognormal and derive
our cross-currency model is driven by a two time parameter random field instead of a finite dimensional Brownian motion. To demonstrate the applications of this model, we develop
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solution for a Quanto cap written on a foreign forward LIBOR rate
formula for Quanto caps and cross-currency swaps
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option written on the spot exchange rate between the domestic and a foreign economy
exchange rate option in the random field setting