TY - JOUR
T1 - Pricing of Basket Options by Conditioning and Moment Matching
JF - The Journal of Derivatives
SP - 80
LP - 87
DO - 10.3905/jod.2020.1.103
VL - 28
IS - 2
AU - Wu, Ping
AU - Lin, Hui
Y1 - 2020/11/30
UR - http://jod.pm-research.com/content/28/2/80.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 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.
ER -