RT Journal Article
SR Electronic
T1 Pricing of Basket Options by Conditioning and Moment Matching
JF The Journal of Derivatives
FD Institutional Investor Journals
SP 80
OP 87
DO 10.3905/jod.2020.1.103
VO 28
IS 2
A1 Wu, Ping
A1 Lin, Hui
YR 2020
UL http://jod.pm-research.com/content/28/2/80.abstract
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.