A Generalized Bachelier Formula for Pricing Basket and Spread Options
19 Pages Posted: 4 Dec 2015
Date Written: November 16, 2015
In this paper we propose a closed-form pricing formula for European basket and spread options. Our approach is based on approximating the risk-neutral probability density function of the terminal value of the basket using a Gauss-Hermite series expansion around the Gaussian density. The new method is quite general as it can be applied for a basket with a large number of assets and for all dynamics where the joint characteristic function of log-returns is known in closed form. We provide a simulation study to show the accuracy and the speed of our methodology.
Keywords: Basket options, Spread options, Option pricing, Gauss-Hermite series expansion
JEL Classification: C63, G13
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