RT Journal Article
SR Electronic
T1 Pricing Composite and Quanto Derivatives under Stochastic Correlation and Stochastic Volatility
JF The Journal of Derivatives
FD Institutional Investor Journals
SP 82
OP 102
DO 10.3905/jod.2014.21.4.082
VO 21
IS 4
A1 Romo, Jacinto Marabel
YR 2014
UL http://jod.pm-research.com/content/21/4/82.abstract
AB There is growing trade in options whose payoffs are a function of multiple stochastic variables. One common type is an option on an asset denominated in one currency with a payoff in a different currency. Two closely related structures of this kind are quantos and composite options. Pricing formulas for European payoff contracts are available under Black–Scholes assumptions, but they require the assumption of constant volatility and correlations, neither of which is supported empirically. Romo develops a model of time-varying volatilities and correlations under a multiasset Wishart process, which is solved using Fourier and Laplace transform methods to produce semi-closed-form valuation equations. One structure especially exposed to stochastic correlation risk is a forward-starting quanto, which is easily priced in this framework.TOPICS: Options, risk management