Smiles all around: FX joint calibration in a multi-Heston model

•We introduce a novel multi-factor Heston-based stochastic volatility model.•We reproduce typical smiles and skews of a multi-dimensional FX vanilla market.•We joint calibrate on real data a triangle of implied volatility surfaces.•The model preserves the natural inversion and triangulation symmetri...

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Bibliographic Details
Published in:Journal of banking & finance 2013-10, Vol.37 (10), p.3799-3818
Main Authors: De Col, Alvise, Gnoatto, Alessandro, Grasselli, Martino
Format: Article
Language:English
Subjects:
Asymmetry
Calibration
Currency transactions
Estimation
Exchange market
Exchange rates
Foreign exchange markets
Forex
Investment policy
Multi-Heston model
Parameter estimation
Stochastic models
Stochastic processes
Studies
Triangular relation
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Summary:•We introduce a novel multi-factor Heston-based stochastic volatility model.•We reproduce typical smiles and skews of a multi-dimensional FX vanilla market.•We joint calibrate on real data a triangle of implied volatility surfaces.•The model preserves the natural inversion and triangulation symmetries. We introduce a novel multi-factor Heston-based stochastic volatility model, which is able to reproduce consistently typical multi-dimensional FX vanilla markets, while retaining the (semi)-analytical tractability typical of affine models and relying on a reasonable number of parameters. A successful joint calibration to real market data is presented together with various in- and out-of-sample calibration exercises to highlight the robustness of the parameters estimation. The proposed model preserves the natural inversion and triangulation symmetries of FX spot rates and its functional form, irrespective of choice of the risk-free currency. That is, all currencies are treated in the same way.
ISSN:0378-4266
1872-6372
DOI:10.1016/j.jbankfin.2013.05.031