Asian Options Can be More Valuable than Plain Vanilla Counterparts

Abstract

Asian options payoffs are based on the average price of the underlying over some time period prior to and including the expiration date. This induces path–dependency, which presents problems for standard option pricing models. One basic principle, though, is that viewed from an initial date t, the standard deviation of the asset price at a future option expiration date T will be greater than the standard deviation of the average price over the period leading up to T. Thus, other things equal, an Asian option should be worth less than the equivalent European option. However, in this article, Ye shows that, in general, other things won't be equal. In particular, the expected value of the average price will also be systematically different from that of the terminal price, as a function of the riskless rate and the dividend yield. Although the volatility will be lower for the Asian option, the pricing relationship can easily be reversed by the difference in expected values. Asian options can, indeed, be worth more than their equivalent plain vanilla counterparts.