Heterogeneous Basket Options Pricing Using Analytical Approximations
39 Pages Posted: 25 Jun 2015
Date Written: June 25, 2015
This paper proposes the use of analytical approximations to price an heterogeneous basket option combining commodity prices, foreign currencies and zero-coupon bonds. The performance of three moment matching approximations is examined: inverse gamma, Edgeworth expansion around the lognormal and Johnson family distributions. Since there is no closed-form formula for basket options, Monte Carlo simulations are carried out to generate the benchmark values. A simulation experiment on a set of options based on a random choice of parameters is performed. The results show that the Edgeworth-lognormal and Johnson distributions give the most accurate results.
Keywords: Basket Options; Options Pricing; Analytical Approximations; Monte Carlo Simulation
JEL Classification: C15, C63, F31, G13
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