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A general closed-form spread option pricing formula

Author

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  • Caldana, Ruggero
  • Fusai, Gianluca

Abstract

We propose a new accurate method for pricing European spread options by extending the lower bound approximation of Bjerksund and Stensland (2011) beyond the classical Black–Scholes framework. This is possible via a procedure requiring a univariate Fourier inversion. In addition, we are also able to obtain a new tight upper bound. Our method provides also an exact closed form solution via Fourier inversion of the exchange option price, generalizing the Margrabe (1978) formula. The method is applicable to models in which the joint characteristic function of the underlying assets forming the spread is known analytically. We test the performance of these new pricing algorithms performing numerical experiments on different stochastic dynamic models.

Suggested Citation

  • Caldana, Ruggero & Fusai, Gianluca, 2013. "A general closed-form spread option pricing formula," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 4893-4906.
    • Handle: RePEc:eee:jbfina:v:37:y:2013:i:12:p:4893-4906
    DOI: 10.1016/j.jbankfin.2013.08.016
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    References listed on IDEAS

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    More about this item

    Keywords

    Spread option; Exchange option; Stochastic process; Characteristic function; Fourier inversion; Control variate;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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