A General Closed-Form Spread Option Pricing Formula

36 Pages Posted: 18 Jan 2014

See all articles by Ruggero Caldana

Ruggero Caldana

Independent

Gianluca Fusai

Università del Piemonte Orientale Dipartimento di Studi per l'Economia e l'Impresa; Sir John Cass Business School - City, University of London

Date Written: June 5, 2013

Abstract

We propose a new accurate method for pricing European spread options by extending the lower bound approximation of Bjerksund and Stensland (2011) beyond the classical Black-Scholes framework. This is possible via a procedure requiring a univariate Fourier inversion. In addition, we are also able to obtain a new tight upper bound. Our method provides also an exact closed form solution via Fourier inversion of the exchange option price, generalizing the Margrabe (1978) formula. The method is applicable to models in which the joint characteristic function of the underlying assets forming the spread is known analytically. We test the performance of these new pricing algorithms performing numerical experiments on different stochastic dynamic models.

Keywords: Spread option, exchange option, stochastic process, characteristic function, Fourier inversion, control variate.

JEL Classification: C63, G13

Suggested Citation

Caldana, Ruggero and Fusai, Gianluca, A General Closed-Form Spread Option Pricing Formula (June 5, 2013). Available at SSRN: https://ssrn.com/abstract=2133923 or http://dx.doi.org/10.2139/ssrn.2133923

Ruggero Caldana (Contact Author)

Independent ( email )

No Address Available

Gianluca Fusai

Università del Piemonte Orientale Dipartimento di Studi per l'Economia e l'Impresa ( email )

Via Perrone, 18
Novara, 28100
Italy

HOME PAGE: http://https://upobook.uniupo.it/gianluca.fusai

Sir John Cass Business School - City, University of London ( email )

106 Bunhill Row
London, EC2Y 8HB
Great Britain

HOME PAGE: http:// www.cass.city.ac.uk/experts/G.Fusai

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