PT - JOURNAL ARTICLE
AU - Wu, Ping
AU - Lin, Hui
TI - Pricing of Basket Options by Conditioning and Moment Matching
AID - 10.3905/jod.2020.1.103
DP - 2020 Nov 30
TA - The Journal of Derivatives
PG - 80--87
VI - 28
IP - 2
4099 - http://jod.pm-research.com/content/28/2/80.short
4100 - http://jod.pm-research.com/content/28/2/80.full
AB - 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 a moment-matching approach. In order to calculate the second part, the authors 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. Their method can be viewed as a combination of conditioning and moment-matching methods. Numerical studies have demonstrated that their 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 log-normal random variable cases.