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Pricing of Volume-Weighted Average Options: Analytical Approximations and Numerical Results

In: Inspired by Finance

Author

Listed:
  • Alexander A. Novikov

    (University of Technology)

  • Timothy G. Ling

    (University of Technology)

  • Nino Kordzakhia

    (Macquarie University)

Abstract

The volume weighted average price (VWAP) over rolling number of days in the averaging period is used as a benchmark price by market participants and can be regarded as an estimate for the price that a passive trader will pay to purchase securities in a market. The VWAP is commonly used in brokerage houses as a quantitative trading tool and also appears in Australian taxation law to specify the price of share-buybacks of publically-listed companies. Most of the existing literature on VWAP focuses on strategies and algorithms to acquire market securities at a price as close as possible to VWAP. In our setup the volume process is modeled via a shifted squared Ornstein-Uhlenbeck process and a geometric Brownian motion is used to model the asset price. We derive the analytical formulae for moments of VWAP and then use the moment matching approach to approximate a distribution of VWAP. Numerical results for moments of VWAP and call-option prices have been verified by Monte Carlo simulations.

Suggested Citation

  • Alexander A. Novikov & Timothy G. Ling & Nino Kordzakhia, 2014. "Pricing of Volume-Weighted Average Options: Analytical Approximations and Numerical Results," Springer Books, in: Yuri Kabanov & Marek Rutkowski & Thaleia Zariphopoulou (ed.), Inspired by Finance, edition 127, pages 461-474, Springer.
    • Handle: RePEc:spr:sprchp:978-3-319-02069-3_21
    DOI: 10.1007/978-3-319-02069-3_21
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