The Pricing of Path-Dependent Structured Financial Retail Products: The Case of Bonus Certificates

Posted: 25 Aug 2008 Last revised: 21 May 2019

See all articles by Rainer Baule

Rainer Baule

University of Hagen

Christian Tallau

Münster University of Applied Sciences

Date Written: January 11, 2011

Abstract

We investigate the pricing of bonus certificates, a popular type of structured financial retail product that features an embedded barrier option. Due to the path-dependency of these products, a classical Black-Scholes valuation is problematic in the presence of the volatility skew. Therefore, in addition to several variants of the Black-Scholes model, we consider the skew-consistent stochastic volatility model of Heston (1993). We analyze how issuers price the volatility skew and to what extent they are able to achieve a profit margin. Evaluating a data sample of 1,057 bonus certificates over a period of 22 months, covering 185,538 quotes, we find that issuers indeed employ a pricing model beyond the Black-Scholes framework. Analyzing the issuers'' margins reveals that margins are relatively large compared to other structured retail products with embedded plain-vanilla options. Average annualized margins range between 1.98% and 3.50% across the issuers. Furthermore, we find that margins are a decreasing function of the products'' lifetime, as well as a decreasing function of the moneyness. This moneyness effect has a substantial impact on annualized margins: With the stock market decline in 2008 and the corresponding decrease in average moneyness, average annualized margins increase from 1%-2% in 2007 to 3%-5% in 2008.

Keywords: certificate, implied volatility, option pricing, stochastic volatility, structured financial product, volatility skew, volatility smile

JEL Classification: G13, G21

Suggested Citation

Baule, Rainer and Tallau, Christian, The Pricing of Path-Dependent Structured Financial Retail Products: The Case of Bonus Certificates (January 11, 2011). Journal of Derivatives, Vol. 18, No. 4, 2011, https://doi.org/10.3905/jod.2011.18.4.054, Available at SSRN: https://ssrn.com/abstract=1254102

Rainer Baule (Contact Author)

University of Hagen ( email )

Universitaetsstrasse 41
Hagen, 58097
Germany

Christian Tallau

Münster University of Applied Sciences ( email )

Corrensstrasse 25
Muenster, 48149
Germany

Do you have negative results from your research you’d like to share?

Paper statistics

Abstract Views
4,446
PlumX Metrics