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A Moment Matching Approach To The Valuation Of A Volume Weighted Average Price Option

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  • ANTONY WILLIAM STACE

    ()
    (Department of Mathematics, University of Queensland, Brisbane, Queensland 4072, Australia)

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    Abstract

    In this paper we develop a method to find the price of several options whose payoff depends on a volume weighted average price (VWAP). Fixed and floating strike VWAP, together with digital VWAP contracts are considered. Throughout we assume that the stock follows a geometric Brownian motion and the rate of trades evolves as a mean reverting process. It is assumed that the VWAP at the final time has a lognormal distribution. The parameters of the approximating lognormal distribution are obtained by matching the first two moments of the volume weighted average price with a lognormal process. A price is then obtained for the fixed strike and digital options when the market price of risk is a constant. We concentrate on the price for calls, prices for puts can be obtained in an analogous manner.

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    Bibliographic Info

    Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.

    Volume (Year): 10 (2007)
    Issue (Month): 01 ()
    Pages: 95-110

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    Handle: RePEc:wsi:ijtafx:v:10:y:2007:i:01:p:95-110

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    Related research

    Keywords: Option pricing; moment matching; volume weighted average price;

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    Cited by:
    1. Alexander Novikov & Nino Kordzakhia, 2013. "On lower and upper bounds for Asian-type options: a unified approach," Science & Finance (CFM) working paper archive 1309.2383, Science & Finance, Capital Fund Management.

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