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Article

A Note to Enhance the BPW Model for the Pricing of Basket and Spread Options

Jui-Jane Chang, Son-Nan Chen and Ting-Pin Wu
The Journal of Derivatives Spring 2012, 19 (3) 77-82; DOI: https://doi.org/10.3905/jod.2012.19.3.077
Jui-Jane Chang
is an assistant professor of finance in the Department of Financial Engineering and Actuarial Mathematics at Soochow University in Taipei, Taiwan (R.O.C.).
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  • For correspondence: jjane@scu.edu.tw
Son-Nan Chen
is a professor of finance in the Shanghai Advanced Institute of Finance (SAIF) at Shanghai Jiao Tong University in Shanghai P.R., China.
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  • For correspondence: slchen@nccu.edu.tw
Ting-Pin Wu
is an associate professor of finance in the Department of Finance at National Central University in Taoyuan County, Taiwan (R.O.C.).
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  • For correspondence: wutingpin@gmail.com
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Abstract

The standard assumption for an underlying asset’s returns process is the lognormal diffusion. This works quite well for individual assets. Portfolios and indexes present a problem, however, because a weighted sum of lognormally distributed stock prices is not lognormal. But a lognormal approximation can typically still be used as long as all of the weights are positive. That condition fails for options on a spread, which generally involves approximately equally sized long and short positions. In the Summer 2007 issue of this journal, Borovkova, Permana, and Weide (BPW) presented a solution based on matching the moments of the returns distribution to a generalized lognormal. Here, Wu, Chang and Chen show how to speed up the BPW procedure considerably by using closed-form expressions for the relevant moments.

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The Journal of Derivatives: 19 (3)
The Journal of Derivatives
Vol. 19, Issue 3
Spring 2012
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A Note to Enhance the BPW Model for the Pricing of Basket and Spread Options
Jui-Jane Chang, Son-Nan Chen, Ting-Pin Wu
The Journal of Derivatives Feb 2012, 19 (3) 77-82; DOI: 10.3905/jod.2012.19.3.077

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A Note to Enhance the BPW Model for the Pricing of Basket and Spread Options
Jui-Jane Chang, Son-Nan Chen, Ting-Pin Wu
The Journal of Derivatives Feb 2012, 19 (3) 77-82; DOI: 10.3905/jod.2012.19.3.077
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  • Article
    • Abstract
    • BRIEF REVIEW OF BPW
    • EFFICIENT MOMENT-MATCHING METHOD
    • NUMERICAL EXAMPLES
    • CONCLUSIONS
    • ENDNOTES
    • REFERENCES
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