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The valuation of forward-start rainbow options

Author

Listed:
  • Chun-Ying Chen
  • Hsiao-Chuan Wang
  • Jr-Yan Wang

Abstract

This paper studies the valuation and hedging problems of forward-start rainbow options (FSROs). By combining the characteristics of both multiple assets and forward-start feature, this new type of derivative has many potential applications, for instance, to incorporate the reset provision in rainbow options for investors or hedgers or design more effective executive compensation plans. The main contribution of this paper is a novel martingale pricing technique for options whose payoffs are associated with multiple assets and time points. Equipped with this technique, the analytic pricing formula and the formulae of the delta and gamma of the FSRO are first derived. We conduct numerical experiments to verify these formulae and examine the characteristics of the FSRO’s price and Greek letters. To demonstrate the importance and general applicability of the proposed technique, we also apply it to deriving the pricing formula for the discrete-sampling lookback rainbow options. Copyright Springer Science+Business Media New York 2015

Suggested Citation

  • Chun-Ying Chen & Hsiao-Chuan Wang & Jr-Yan Wang, 2015. "The valuation of forward-start rainbow options," Review of Derivatives Research, Springer, vol. 18(2), pages 145-188, July.
    • Handle: RePEc:kap:revdev:v:18:y:2015:i:2:p:145-188
    DOI: 10.1007/s11147-014-9105-0
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    References listed on IDEAS

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    1. Stulz, ReneM., 1982. "Options on the minimum or the maximum of two risky assets : Analysis and applications," Journal of Financial Economics, Elsevier, vol. 10(2), pages 161-185, July.
    2. Stephen F. Gray & Robert E. Whaley, 1999. "Reset Put Options: Valuation, Risk Characteristics, and an Application," Australian Journal of Management, Australian School of Business, vol. 24(1), pages 1-20, June.
    3. Johnson, Herb, 1987. "Options on the Maximum or the Minimum of Several Assets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(3), pages 277-283, September.
    4. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    5. Margrabe, William, 1978. "The Value of an Option to Exchange One Asset for Another," Journal of Finance, American Finance Association, vol. 33(1), pages 177-186, March.
    6. Szu‐Lang Liao & Chou‐Wen Wang, 2003. "The valuation of reset options with multiple strike resets and reset dates," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 23(1), pages 87-107, January.
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    Citations

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    Cited by:

    1. Ravi Kashyap, 2022. "Options as Silver Bullets: Valuation of Term Loans, Inventory Management, Emissions Trading and Insurance Risk Mitigation using Option Theory," Annals of Operations Research, Springer, vol. 315(2), pages 1175-1215, August.
    2. Wang, Xingchun, 2020. "Pricing options on the maximum or minimum of multi-assets under jump-diffusion processes," International Review of Economics & Finance, Elsevier, vol. 70(C), pages 16-26.
    3. Ravi Kashyap, 2016. "Options as Silver Bullets: Valuation of Term Loans, Inventory Management, Emissions Trading and Insurance Risk Mitigation using Option Theory," Papers 1609.01274, arXiv.org, revised Mar 2022.

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    More about this item

    Keywords

    Discrete-sampling path-dependent option; Rainbow option; Forward-start option; Reset option; Lookback option; G13;
    All these keywords.

    JEL classification:

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

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