General Closed-Form Basket Option Pricing Bounds

Abstract

This article presents lower and upper bounds on the prices of basket options for a general class of continuous-time financial models. The techniques we propose are applicable whenever the joint characteristic function of the vector of log-returns is known in closed-form. Moreover, the basket value is not required to be positive. We test our new bounds on different multivariate models, allowing for jumps and stochastic volatility. Numerical examples are discussed and benchmarked against Monte Carlo simulations. All bounds are general and do not require any additional assumption on the characteristic function, so our methods may be employed also to non-affine models. All bounds involve the computation of one-dimensional Fourier transforms, hence they do not suffer from the curse of dimensionality. In particular, our new lower bound turns out to be fast and accurate.

Keywords: Basket option, Lower Bound, Non Gaussian models, Upper Bound, Fourier Transform, Exotic option

JEL Classification: G12, G13