The Valuation of Reset Options When Underlying Assets are Autocorrelated

The International Journal of Business and Finance Research, Vol. 5, No. 2, pp. 95-114, 2011

20 Pages Posted: 3 Jul 2011

See all articles by Yu-Hong Liu

Yu-Hong Liu

National Cheng Kung University

I-Ming Jiang

Yuan Ze University

Shih-Cheng Lee

Yuan Ze University

Yu-Ting Cheng

affiliation not provided to SSRN

Date Written: 2011

Abstract

This paper introduces the autocorrelation effect of assets’ returns into the valuation model of reset options. The MA(q) process, which is an extension of MA(1) process noted by Liao and Chen (2006), is applied to the valuation of reset options in this paper. Due to the impact of autocorrelation on the volatility of assets’ returns, the probability of reset and the value of reset option are affected. Positive autocorrelation increases the value of a reset option by increasing the probability of reset. On the contrary, negative autocorrelation decreases the probability of a reset and reset premium. Moreover, the reset timing is affected by the autocorrelation characteristics. In the case of positive autocorrelation, the investors tend to reset earlier to prevent a possible loss. Positive autocorrelation is also significant for the hedging of reset options. This paper demonstrates that positive autocorrelation characteristics lessens the delta jump and gamma jump problem.

Keywords: Reset Option, Autocorrelation; MA(q) process, Delta Jump; Gamma Jump

JEL Classification: G12, G13

Suggested Citation

Liu, Yu-Hong and Jiang, I-Ming and Lee, Shih-Cheng and Cheng, Yu-Ting, The Valuation of Reset Options When Underlying Assets are Autocorrelated (2011). The International Journal of Business and Finance Research, Vol. 5, No. 2, pp. 95-114, 2011, Available at SSRN: https://ssrn.com/abstract=1876121

Yu-Hong Liu (Contact Author)

National Cheng Kung University ( email )

No.1, University Road
Tainan
Taiwan

I-Ming Jiang

Yuan Ze University ( email )

135, Far-East Rd., Chung-Li
Taoyuan, ROC
Taiwan

Shih-Cheng Lee

Yuan Ze University ( email )

135, Far-East Rd., Chung-Li
Taoyuan, ROC
Taiwan

Yu-Ting Cheng

affiliation not provided to SSRN

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