Market Pricing of Exotic Structured Products: The Case of Multi-Asset Barrier Reverse Convertibles in Switzerland

Abstract

The market for structured financial products in Switzerland is considered the largest in the world. Its most successful products are multi-asset reverse convertibles with knock-in barriers. We analyze whether these complex instruments are fairly priced. Using a numerical, tree-based valuation method, we obtain an average overpricing of at least 3.4% for 468 certificates outstanding in April 2007. This premium on the entire product corresponds to a price discount of 29% on its embedded short put. The overpricing is positively related to the coupon level, indicating that investors tend to overweight the sure coupon and underestimate the risk involved. This behavioral bias appears to be important in explaining the success of the product.

Keywords: Structured products, reverse convertibles, multi-asset options, barrier options, fair pricing, financial engineering

JEL Classification: G13, G15, G14