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Pricing of arithmetic basket options by conditioning

Author

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  • Griselda Deelstra
  • Jan Liinev
  • Michèle Vanmaele

Abstract

Determining the price of a basket option is not a trivial task, because there is no explicit analytical expression available for the distribution of the weighted sum of prices of the assets in the basket. However, by using a conditioning variable, this price can be decomposed in two parts, one of which can be computed exactly. For the remaining part we first derive a lower and an upper bound based on comonotonicity, and another upper bound equal to that lower bound plus an error term. Secondly, we derive an approximation by applying some moment matching method.

Suggested Citation

  • Griselda Deelstra & Jan Liinev & Michèle Vanmaele, 2004. "Pricing of arithmetic basket options by conditioning," ULB Institutional Repository 2013/7600, ULB -- Universite Libre de Bruxelles.
    • Handle: RePEc:ulb:ulbeco:2013/7600
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    References listed on IDEAS

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    1. Kaas, Rob & Dhaene, Jan & Goovaerts, Marc J., 2000. "Upper and lower bounds for sums of random variables," Insurance: Mathematics and Economics, Elsevier, vol. 27(2), pages 151-168, October.
    2. Michael Curran, 1994. "Valuing Asian and Portfolio Options by Conditioning on the Geometric Mean Price," Management Science, INFORMS, vol. 40(12), pages 1705-1711, December.
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