Options on the Minimum or the Maximum of Two Average Prices

Authors: Wu X.; Zhang J.E.

Source: Review of Derivatives Research, Volume 3, Number 2, 1999 , pp. 183-204(22)

Publisher: Springer

Buy & download fulltext article:

Price: $47.00 plus tax (Refund Policy)

Abstract:

This paper studies options on the minimum/maximum of two average prices. We provide a closed-form pricing formula for the option with geometric averaging starting at any time before maturity. We show overwhelming numerical evidence that the variance reduction technique with the help of the above closed-form solution dramatically improves the accuracy of the simulated price of an option with arithmetic averaging. The proposed options are found widely applicable in risk management and in the design of incentive contracts. The paper also discusses some parity relationships within the family of average-rate options and provides the upper and lower bounds for the proposed options with arithmetic averaging.

Keywords: option; average-rate; rainbow; risk management; incentive contract

Language: English

Document Type: Regular paper

Affiliations: 1: Department of Economics & Finance, City University of Hong Kong, 83 Tat Chee Avenue, Kowloon, Hong Kong

Publication date: 1999-01-01