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Rainbow trend options: valuation and applications

Author

Listed:
  • Jr-Yan Wang

    (National Taiwan University)

  • Hsiao-Chuan Wang

    (National Taiwan University)

  • Yi-Chen Ko

    (National Taiwan University)

  • Mao-Wei Hung

    (National Taiwan University)

Abstract

Asset selection and timing decisions are major investment concerns. To resolve these issues simultaneously, a new class of rainbow trend options is proposed. The diversification effect of rainbow options can reduce the importance of asset selection decisions and trend options can mitigate unfavorable effects on market entry and exit decisions. We consider a general framework to facilitate the derivation of analytic pricing formulas for simple, pure, and Asian rainbow trend options using the martingale pricing method. The properties of these options and their Greeks are analyzed. We also investigate the performance of the dynamic delta hedging strategy for issuers of rainbow trend options. Last, this paper explores the applications of rainbow trend options for hedging price risks, designing executive stock options, modifying countercyclical capital buffer proposed by Basel Committee, and acting as control variates of the Monte Carlo simulation.

Suggested Citation

  • Jr-Yan Wang & Hsiao-Chuan Wang & Yi-Chen Ko & Mao-Wei Hung, 2017. "Rainbow trend options: valuation and applications," Review of Derivatives Research, Springer, vol. 20(2), pages 91-133, July.
    • Handle: RePEc:kap:revdev:v:20:y:2017:i:2:d:10.1007_s11147-016-9125-z
    DOI: 10.1007/s11147-016-9125-z
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    References listed on IDEAS

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    Cited by:

    1. Hong Mao & Zhongkai Wen, 2019. "Pricing options of security portfolio in cyclical economic environment," Journal of Asset Management, Palgrave Macmillan, vol. 20(5), pages 384-394, September.
    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.

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    More about this item

    Keywords

    Rainbow option; Trend option; Timing risk; Asset selection; Martingale pricing method;
    All these keywords.

    JEL classification:

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

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