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Abstract
Quanto options are options where the payout is paid in a currency different from the currency in which the underlying asset is traded and where the applied foreign exchange rate between the two currencies is set to one. The fixed forex rate allows the holder of a quanto option to participate in the performance of the underlying without carrying the risk of a changing forex rate. However, pricing and risk-managing quanto options on foreign equities has become increasingly challenging in recent years due to high levels of equity/forex correlation and high volatility. Both market parameters determine the well-known quanto adjustment in the drift of the underlying, as derived by Reiner (1992) in the classical Black-Scholes model. While most of the research on quanto options has focused on the Black-Scholes framework, researchers recently started to study quanto options in the context of stochastic volatility models, which allow skews and smiles in the implied volatility surface of the underlying asset.