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Approximate analytic solution for Asian options with stochastic volatility

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  • Lin, Chung-Gee
  • Chang, Chia-Chang

Abstract

The valuation of Asian options is complicated because the arithmetic average of lognormal random variables is no longer lognormal. Furthermore, the stochastic volatility inherent in financial asset prices is easily observed. However, few academic studies consider the pricing and hedging of Asian options with stochastic volatility, despite the popularity of such options. This study extends the work of Hull and White (1987) and integrates the Taylor series expansion technique to derive an approximate analytic solution for Asian options with stochastic volatility. Numerical experiments show that the proposed approximate analytic solution performs favorably and is computationally efficient compared with large-sample simulations. The approximate analytic solution provides a practical approach for pricing and hedging Asian options with stochastic volatility and is both easy to implement and desirable in terms of computing speed.

Suggested Citation

  • Lin, Chung-Gee & Chang, Chia-Chang, 2020. "Approximate analytic solution for Asian options with stochastic volatility," The North American Journal of Economics and Finance, Elsevier, vol. 54(C).
    • Handle: RePEc:eee:ecofin:v:54:y:2020:i:c:s1062940818305734
    DOI: 10.1016/j.najef.2019.03.014
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    References listed on IDEAS

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    More about this item

    Keywords

    Asian option; Approximate analytic solution; Lognormal; Stochastic volatility; Taylor series expansion;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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