The Pricing of Path-Dependent Structured Financial Retail Products: The Case of Bonus Certificates
Posted: 25 Aug 2008 Last revised: 21 May 2019
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: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Reverse Convertible Bonds Analyzed
By Marta Szymanowska, Jenke Ter Horst, ...
-
Probability Misestimation and Preferences in Financial Investment Decision
-
The Order Flow of Discount Certificates and Issuer Pricing Behavior
By Rainer Baule
-
Beyond Payoff Diagrams: How to Present Risk and Return Characteristics of Structured Products
-
Multivariate Downside Risk: Normal Versus Variance Gamma
By Martin Wallmeier and Martin Diethelm
-
By Peter Løchte Jørgensen, Henrik Nørholm, ...
-
Explaining the Demand for Structured Financial Products: Survey and Field Experiment Evidence
By Marc Oliver Rieger and Thorsten Hens
-
Pricing and Upper Price Bounds of Relax Certificates
By Nicole Branger, Antje Brigitte Mahayni, ...
-
Valuation of Reverse Convertibles in the Variance Gamma Economy
By Geng Deng, Tim Dulaney, ...