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Bivariate option pricing with copulas

Author

Listed:
  • U. Cherubini
  • E. Luciano

Abstract

The adoption of copula functions is suggested in order to price bivariate contingent claims. Copulas enable the marginal distributions extracted from vertical spreads in the options markets to be imbedded in a multivariate pricing kernel. It is proved that such a kernel is a copula function, and that its super-replication strategy is represented by the Frechet bounds. Applications provided include prices for binary digital options, options on the minimum and options to exchange one asset for another. For each of these products, no-arbitrage pricing bounds, as well as values consistent with the independence of the underlying assets are provided. As a final reference value, a copula function calibrated on historical data is used.

Suggested Citation

  • U. Cherubini & E. Luciano, 2002. "Bivariate option pricing with copulas," Applied Mathematical Finance, Taylor & Francis Journals, vol. 9(2), pages 69-85.
    • Handle: RePEc:taf:apmtfi:v:9:y:2002:i:2:p:69-85
    DOI: 10.1080/13504860210136721a
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    References listed on IDEAS

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    1. Joshua Rosenberg, 1999. "Semiparametric Pricing of Multivariate Contingent Claims," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-028, New York University, Leonard N. Stern School of Business-.
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    7. Rubinstein, Mark, 1994. "Implied Binomial Trees," Journal of Finance, American Finance Association, vol. 49(3), pages 771-818, July.
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