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The Journal of Derivatives

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Article

A General Accurate Approximation for Pricing and Hedging Basket Options with Exact Moment Matching

Feifan Wu, Xundi Diao and Chongfeng Wu
The Journal of Derivatives Spring 2019, jod.2019.1.072; DOI: https://doi.org/10.3905/jod.2019.1.072
Feifan Wu
is a post doctor at Antai College of Economics & Management, Shanghai Jiatotong University, Shanghai, China
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Xundi Diao
is an assistant professor at Antai College of Economics & Management, Shanghai Jiatotong University, Shanghai, China
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Chongfeng Wu
is a professor at Antai College of Economics & Management, Shanghai Jiatotong University, Shanghai, China
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Abstract

This paper provides a new methodology for pricing and hedging basket options. The authors approximate the basket by using the shifted log-normal distribution with the polynomial expansion, which can match exactly any required m moments of the basket, to give quasi-analytical formulas for the prices and hedging parameters of basket options. Numerical simulations show that the methodology provides superior results for basket option prices and hedging parameters. This methodology works well not only for regular baskets but also for negative-weight baskets and negative-value baskets. Compared with the best available methods, the authors’ methodology appears to perform better.

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The Journal of Derivatives: 29 (5)
The Journal of Derivatives
Vol. 29, Issue 5
Summer 2022
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A General Accurate Approximation for Pricing and Hedging Basket Options with Exact Moment Matching
Feifan Wu, Xundi Diao, Chongfeng Wu
The Journal of Derivatives Feb 2019, jod.2019.1.072; DOI: 10.3905/jod.2019.1.072

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A General Accurate Approximation for Pricing and Hedging Basket Options with Exact Moment Matching
Feifan Wu, Xundi Diao, Chongfeng Wu
The Journal of Derivatives Feb 2019, jod.2019.1.072; DOI: 10.3905/jod.2019.1.072
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  • Article
    • Abstract
    • PRIMARIES
    • MATCHING MOMENTS
    • PRICING AND HEDGING METHODOLOGY
    • PRICING AND HEDGING FORMULAS: NEGATIVE-VALUE BASKETS
    • SUMMARIZATION AND REMARKS OF THE METHODOLOGY
    • NUMERICAL COMPARISONS
    • CONCLUSIONS
    • ACKNOWLEDGMENT
    • APPENDIX
    • REFERENCES
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