The next FE-635 notes explain why a single Black–Scholes volatility is not enough for an FX market. Discrete hedging creates P&L even when the model's inputs are correct, and volatility is uncertain rather than fixed.
\nOptions with different strikes imply different volatilities. The resulting smile or skew is a market summary of tail demand, quotation conventions, and the limits of the log-normal model. Calibration therefore fits a surface of prices or implied volatilities instead of forcing every option through one number.
\nThe practical implication is clear: risk must be revalued under shocks to both spot and the volatility surface. A delta-only report can miss the largest loss when the smile moves with the underlying.
","contentMarkdown":"The next FE-635 notes explain why a single Black–Scholes volatility is not enough for an FX market. Discrete hedging creates P&L even when the model's inputs are correct, and volatility is uncertain rather than fixed.\n\nOptions with different strikes imply different volatilities. The resulting smile or skew is a market summary of tail demand, quotation conventions, and the limits of the log-normal model. Calibration therefore fits a surface of prices or implied volatilities instead of forcing every option through one number.\n\nThe practical implication is clear: risk must be revalued under shocks to both spot and the volatility surface. A delta-only report can miss the largest loss when the smile moves with the underlying.","dataUrl":"https://sharifhsn.dev/api/posts/fx-volatility-smiles-and-uncertainty.json","date":"2025-03-10","datePublished":"2025-03-10","description":"The next FE-635 notes explain why a single Black–Scholes volatility is not enough for an FX market. Discrete hedging creates P&L even when the model's inputs are correct, and volat…","site":"https://sharifhsn.dev","slug":"fx-volatility-smiles-and-uncertainty","source":"FE-635 | Risk Engineering","sourceUrl":null,"tags":["FX","Volatility","Smiles"],"title":"FX Volatility Smiles and Uncertainty","url":"https://sharifhsn.dev/blog/fx-volatility-smiles-and-uncertainty/","version":"1","wordCount":114}