Market Pricing of Exotic Structured Products: The Case of Multi-Asset Barrier Reverse Convertibles in Switzerland

Abstract

Exotic option structures are not as popular in the market as they once were but one type, multi-asset barrier reverse convertibles (MBRCs), continues to be actively traded in Switzerland. The underlying is a portfolio containing several stocks, typically three, and the payoff depends on whether any of them reaches a pre-specified barrier level during the life of the security. Like an ordinary convertible bond, there is a set coupon rate, but at maturity the holder receives either the bond’s face value or, alternatively, some quantity of the worst-performing of the stocks if any one of them has hit its barrier. The authors develop a clever valuation technique based on a multinomial tree and use it to examine how MBRCs are priced in the market. They show that prices exceed model values on average, with greater overpricing when the stocks are less commonly used in MBRCs and for those denominated in low interest rate currencies.