Heterogeneous Basket Options Pricing Using Analytical Approximations

Dionne  , Georges; Gauthier, Genevieve; Ouertani , Nadia; Tahani, Nabil

Volume 15, Numbers 1 & 2 / March/June , Pages 1-156

Multinational Finance Journal, 2011, vol. 15, no. 1/2, pp. 47-85

Georges Dionne , HEC Montreal, Canada Corresponding Author

Genevieve Gauthier , HEC Montreal, Canada
Nadia Ouertani , LEFA, ISCAE Manouba University, Tunisia
Nabil Tahani , York University, Canada

Abstract:
This paper proposes the use of analytical approximations to price an heterogeneous basket option combining commodity prices, foreign currencies and zero-coupon bonds. The performance of three moment matching approximations is examined: inverse gamma, Edgeworth expansion around the lognormal and Johnson family distributions. Since there is no closed-form formula for basket options, Monte Carlo simulations are carried out to generate the benchmark values. A simulation experiment on a set of options based on a random choice of parameters is performed. The results show that the Edgeworth-lognormal and Johnson distributions give the most accurate results.

Keywords : Basket Options; Options Pricing; Analytical Approximations; Monte Carlo Simulation
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