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On the closed-form approximation of short-time random strike options

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    In this paper we propose a general technique to develop first and second order closed-form approximation formulas for short-time options with random strikes. Our method is based on Malliavin calculus techniques and allows us to obtain simple closed-form approximation formulas depending on the derivative operator. The numerical analysis shows that these formulas are extremely accurate and improve some previous approaches on two-assets and three-assets spread options as Kirk's formula or the decomposition mehod presented in Alòs, Eydeland and Laurence (2011).

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    File URL: http://www.econ.upf.edu/docs/papers/downloads/1347.pdf
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    Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1347.

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    Date of creation: May 2013
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    Handle: RePEc:upf:upfgen:1347
    Contact details of provider: Web page: http://www.econ.upf.edu/

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    1. Aanand Venkatramanan & Carol Alexander, 2011. "Closed Form Approximations for Spread Options," Applied Mathematical Finance, Taylor & Francis Journals, vol. 18(5), pages 447-472, January.
    2. Margrabe, William, 1978. "The Value of an Option to Exchange One Asset for Another," Journal of Finance, American Finance Association, vol. 33(1), pages 177-86, March.
    3. Eric Renault & Nizar Touzi, 1996. "Option Hedging And Implied Volatilities In A Stochastic Volatility Model," Mathematical Finance, Wiley Blackwell, vol. 6(3), pages 279-302.
    4. Bjerksund, Petter & Stensland, Gunnar, 2006. "Closed form spread option valuation," Discussion Papers 2006/20, Department of Business and Management Science, Norwegian School of Economics.
    5. Li, Minqiang, 2008. "Closed-Form Approximations for Spread Option Prices and Greeks," MPRA Paper 6994, University Library of Munich, Germany.
    6. Alexey Medvedev & Olivier Scaillet, . "Approximation and Calibration of Short-Term Implied Volatilities under Jump-Diffusion Stochastic Volatility," Swiss Finance Institute Research Paper Series 06-08, Swiss Finance Institute, revised Jan 2006.
    7. Jean-Pierre Fouque & George Papanicolaou & Ronnie Sircar & Knut Solna, 2004. "Maturity cycles in implied volatility," Finance and Stochastics, Springer, vol. 8(4), pages 451-477, November.
    8. Jean Jacod & Philip Protter, 2010. "Risk-neutral compatibility with option prices," Finance and Stochastics, Springer, vol. 14(2), pages 285-315, April.
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