Quanto adjustment
Quantitative Finance glossary · Derivatives Pricing & Volatility Surfaces
Definition
The drift correction applied when an underlying's payoff is settled in a different currency than the underlying's natural currency.
Quanto adjustment in plain English
Say a Japanese investor bets on the U.S. stock market but wants to be paid in yen, treating each dollar of gain as if it were one yen — no currency conversion risk. That convenience isn't free to price, because the dollar market and the yen world move together in subtle ways, and ignoring that link would misprice the bet. The quanto adjustment is a small correction to the expected growth rate (the 'drift') that accounts for how the asset and the exchange rate wiggle together, so the cross-currency payoff is valued correctly. Think of it as a tax the math charges for pretending two currencies are one.
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