Minerva Investment Management Society

Quantitative Research Paper

Dupire’s Local Volatility Model and Its Use on FX Exotic Desks

· Quantitative Research

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Summary

This paper examines how Dupire’s local volatility framework links liquid vanilla FX option markets to the pricing and risk management of path-dependent exotic derivatives. The research covers the derivation of the Dupire formula, its adaptation to foreign exchange markets, the construction of FX volatility smiles from ATM, risk reversal and butterfly quotes, and the use of local volatility models in pricing products such as barrier options, one-touches, no-touches and target redemption forwards.

A key conclusion is that while local volatility remains a powerful benchmark and calibration tool for FX exotic desks, pure local volatility has important limitations, especially when it comes to smile dynamics and hedging. For this reason, modern desks often rely on stochastic volatility or local-stochastic volatility extensions for production pricing and risk management.

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Details

Published
26 May 2026
Division
Quantitative Research
Type
Quantitative Research Paper
Pages
28
Authors
2

Cite this report

Minerva Investment Management Society (2026). Dupire’s Local Volatility Model and Its Use on FX Exotic Desks. Quantitative Research. https://minervaims.org/archive/dupires-local-volatility-model-and-its-use-on-fx-exotic-desks-2026

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