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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)

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.

Suggested Citation

  • Kokholm, Thomas, 2008. "Pricing of Traffic Light Options and other Correlation Derivatives," Finance Research Group Working Papers F-2008-01, University of Aarhus, Aarhus School of Business, Department of Business Studies.
  • Handle: RePEc:hhb:aarbfi:2008-01
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    File URL: http://research.asb.dk/fbspretrieve/1355/F-2008-01
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    References listed on IDEAS

    as
    1. Farshid Jamshidian, 1997. "LIBOR and swap market models and measures (*)," Finance and Stochastics, Springer, vol. 1(4), pages 293-330.
    2. 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 409-430, March.
    3. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
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    Keywords

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

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