An Affine Multicurrency Model with Stochastic Volatility and Stochastic Interest Rates

Abstract

We introduce a tractable multicurrency model with stochastic volatility and correlated stochastic interest rates that takes into account the smile in the foreign exchange (FX) market and the evolution of yield curves. The pricing of vanilla options on FX rates can be efficiently performed through the FFT methodology thanks to the affine property of the model. Our framework is also able to describe many nontrivial links between FX rates and interest rates: a calibration exercise highlights the ability of the model to simultaneously fit FX implied volatilities while being coherent with interest rate product