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A simple efficient approximation to price basket stock options with volatility smile

Content Provider	Springer Nature Link
Author	Wu, Ping Elliott, Robert J.
Copyright Year	2017
Abstract	This paper develops a new approach to obtain the price and risk sensitivities of basket options which have a volatility smile. Using this approach, the Black–Scholes model and the Stochastic Volatility Inspired model have been used to obtain an approximate analytical pricing formula for basket options with a volatility smile. It is found that our approximate formula is quite accurate by comparing it with Monte Carlo simulations. It is also proved the option value of our approach is consistent with the option value generated by Levy’s and Gentle’s approaches for typical ranges of volatility. Further, we give a theoretical proof that the option values from Levy’s and Gentle’s works are the upper bound and the lower bound, respectively, for our option value. The calibration procedure and a practical example are provided. The main advantage of our approach is that it provides accurate and easily implemented basket option prices with volatility smile and hedge parameters and avoids the need to use time-consuming numerical procedures such as Monte Carlo simulation.
Starting Page	1
Ending Page	29
Page Count	29
File Format	PDF
ISSN	16142446
Journal	Annals of Finance
Volume Number	13
Issue Number	1
e-ISSN	16142454
Language	English
Publisher	Springer Berlin Heidelberg
Publisher Date	2017-01-30
Publisher Place	Berlin, Heidelberg
Access Restriction	One Nation One Subscription (ONOS)
Subject Keyword	Basket options Levy’s method Gentle’s method Log-normal approximation Finance Economic Theory/Quantitative Economics/Mathematical Methods Quantitative Finance Macroeconomics/Monetary Economics//Financial Economics
Content Type	Text
Resource Type	Article
Subject	Finance

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