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Closed form spread option valuation

  • Bjerksund, Petter

    ()

    (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

  • Stensland, Gunnar

    ()

    (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

This paper considers the valuation of a spread call when asset prices are lognormal. The implicit strategy of the Kirk formula is to exercise if the price of the long asset exceeds a given power function of the price of the short asset. We derive a formula for the spread call value, conditional on following this feasible but non-optimal exercise strategy. Numerical investigations indicate that the lower bound produced by our formula is extremely accurate. The precision is much higher than the Kirk formula. Moreover, optimizing with respect to the strategy parameters (which corresponds to the Carmona-Durrleman procedure) yields only a marginal improvement of accuracy (if any).

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File URL: http://hdl.handle.net/11250/164108
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Paper provided by Department of Business and Management Science, Norwegian School of Economics in its series Discussion Papers with number 2006/20.

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Length: 18 pages
Date of creation: 01 Dec 2006
Date of revision:
Handle: RePEc:hhs:nhhfms:2006_020
Contact details of provider: Postal: NHH, Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway
Phone: +47 55 95 92 93
Fax: +47 55 95 96 50
Web page: http://www.nhh.no/en/research-faculty/department-of-business-and-management-science.aspx
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