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Pricing of Traffic Light Options and other Correlation Derivatives

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  • Kokholm, Thomas

    ()
    (Department of Business Studies, Aarhus School of Business)

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    Abstract

    This paper considers derivatives with payo¤s that depend on a stock index and underlying LIBOR rates. A tra¢ c light option pricing formula is derived un- der lognormality assumptions on the underlying processes. The tra¢ c light option is aimed at the Danish life and pension sector to help companies stay solvent in the tra¢ c light stress test system introduced by the Danish Financial Supervisory Authorities in 2001. Similar systems are now being implemented in several other European countries. A pricing approach for general payo¤s is presented and illustrated with simulation via the pricing of a hybrid derivative known as the EUR Sage Note. The approach can be used to price many existing structured products.

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    File URL: http://research.asb.dk/fbspretrieve/1355/F-2008-01
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    Bibliographic Info

    Paper provided by University of Aarhus, Aarhus School of Business, Department of Business Studies in its series Finance Research Group Working Papers with number F-2008-01.

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    Length: 28 pages
    Date of creation: 19 Feb 2008
    Date of revision:
    Handle: RePEc:hhb:aarbfi:2008-01

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    Postal: The Aarhus School of Business, Fuglesangs Allé 4, DK-8210 Aarhus V, Denmark
    Fax: + 45 86 15 19 43
    Web page: http://www.asb.dk/about/departments/bs.aspx
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    Related research

    Keywords: LIBOR market model; traffic light option; correlation; simulation; derivatives pricing; structured products;

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    1. Miltersen, Kristian R & Sandmann, Klaus & Sondermann, Dieter, 1997. " Closed Form Solutions for Term Structure Derivatives with Log-Normal Interest Rates," Journal of Finance, American Finance Association, vol. 52(1), pages 409-30, March.
    2. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
    3. Farshid Jamshidian, 1997. "LIBOR and swap market models and measures (*)," Finance and Stochastics, Springer, vol. 1(4), pages 293-330.
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