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Analytical pricing of discretely monitored Asian-style options: Theory and application to commodity markets

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  • Fusai, Gianluca
  • Marena, Marina
  • Roncoroni, Andrea

Abstract

We compute an analytical expression for the moment generating function of the joint random vector consisting of a spot price and its discretely monitored average for a large class of square-root price dynamics. This result, combined with the Fourier transform pricing method proposed by Carr and Madan [Carr, P., Madan D., 1999. Option valuation using the fast Fourier transform. Journal of Computational Finance 2(4), Summer, 61-73] allows us to derive a closed-form formula for the fair value of discretely monitored Asian-style options. Our analysis encompasses the case of commodity price dynamics displaying mean reversion and jointly fitting a quoted futures curve and the seasonal structure of spot price volatility. Four tests are conducted to assess the relative performance of the pricing procedure stemming from our formulae. Empirical results based on natural gas data from NYMEX and corn data from CBOT show a remarkable improvement over the main alternative techniques developed for pricing Asian-style options within the market standard framework of geometric Brownian motion.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 32 (2008)
Issue (Month): 10 (October)
Pages: 2033-2045

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Handle: RePEc:eee:jbfina:v:32:y:2008:i:10:p:2033-2045

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Keywords: C63 G13 Asian options Discrete monitoring Laplace transform Fourier transform Commodity markets Energy markets;

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Cited by:
  1. Álvaro Cartea & Carlos González-Pedraz, 2010. "How much should we pay for interconnecting electricity markets? A real options approach," Business Economics Working Papers, Universidad Carlos III, Departamento de Economía de la Empresa wb103206, Universidad Carlos III, Departamento de Economía de la Empresa.
  2. Chiarella, Carl & Kang, Boda & Nikitopoulos, Christina Sklibosios & Tô, Thuy-Duong, 2013. "Humps in the volatility structure of the crude oil futures market: New evidence," Energy Economics, Elsevier, Elsevier, vol. 40(C), pages 989-1000.

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