FXfront-officeconcept
FX Volatility Smile
Construct an FX smile from ATM, risk reversal and butterfly quotes.
01Intuition
Build the mental model first.
FX desks quote the centre, asymmetry and wing richness rather than every strike directly.
ONE-LINE DEFINITION
Construct an FX smile from ATM, risk reversal and butterfly quotes.
02Mathematics
Now make it exact.
Notation and units
Decimal rates and volatilities, year-fraction time and continuous compounding unless stated otherwise.
03Assumptions
Every model has a price.
01
Educational conventions are stated explicitly and may simplify market quotation or settlement details.
02
Rates are continuously compounded unless the section says otherwise.
03
Inputs are deterministic in the base model.
“An unstated convention is a future reconciliation break.”— THEQUANTBATEMAN
04Market use
Why a quant cares.
Vanilla marking, strike construction and exotic calibration.
Intuition→Mathematics→Implementation→Desk risk
05Desk view
FRONT OFFICE VIEW
The hedge has opinions.
Start with the quote convention, then ask which FX risk survives the hedge. A number without its convention is merely well-dressed ambiguity.
Ask Bateman about this model →06Related