TY - JOUR
T1 - Pricing of Basket Options by Conditioning and Moment Matching
JF - The Journal of Derivatives
DO - 10.3905/jod.2020.1.103
SP - jod.2020.1.103
AU - Wu, Ping
AU - Lin, Hui
Y1 - 2020/04/17
UR - http://jod.pm-research.com/content/early/2020/04/17/jod.2020.1.103.abstract
N2 - The price of basket options can be represented as an exact analytical part and an approximate part by using a conditional variable. The first part is calculated by conditioning on the price process of the underlying asset and the second part is calculated by moment matching approach. In order to calculate the second part, we find a new single random variable, which has an analytically known distribution, to approximate the sum of log-normal random variables and to obtain a closed form pricing formula. Our method can be viewed as a combination of conditioning and moment matching methods. Numerical studies demonstrated that our formula is more accurate in handling both homogeneous and heterogeneous lognormal random variable cases.TOPICS: Derivatives, optionsKey Findings• The price of basket options can be represented as an exact analytical part and an approximate part by using a conditional variable. In order to calculate the approximate part, we find a new single random variable, which has an analytically known distribution, to approximate the sum of log-normal random variables and to obtain a closed form pricing formula.• Numerical studies demonstrate that our formula is more accurate in handling both homogeneous and heterogeneous lognormal random variable cases.
ER -