Approximate valuation of average options

Approximate valuation of average options

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Article ID: iaor1994807
Country: Switzerland
Volume: 45
Issue: 1/4
Start Page Number: 131
End Page Number: 145
Publication Date: Dec 1993
Journal: Annals of Operations Research
Authors: , ,
Abstract:

This paper concerns the valuation of average options of European type where an investor has the right to buy the average of an asset price process over some time interval, as the terminal price, at a prespecified exercise price. A discrete model is first constructed and a recurrence formula is derived for the exact price of the discrete average call option. For the continuous average call option price, the authors derive some approximations and theoretical upper and lower bounds. These approximations are shown to be very accurate for at-the-money and in-the-money cases compared to the simulation results. The theoretical bounds can be used to provide useful information in pricing average options.

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