What is the volatility of an Asian option?
Risk, May 2021 Issue, 74-79
16 Pages Posted: 8 Jul 2021 Last revised: 21 Jul 2021
Date Written: June 29, 2021
Abstract
We propose a simple approximation for pricing Asian options on an underlying asset with an implied volatility smile by substituting an appropriately adjusted volatility into a Black-Scholes pricer which takes a constant volatility. For Asian options with strikes close to the at-the-money point, the adjustment is independent of the shape of the volatility smile at leading order in an expansion in log-strike, which makes it robust against calibration errors. The smile adjusted valuation becomes exact for Asian options with continuous time averaging in the short maturity limit in the local volatility model.
Keywords: Asian options, implied volatility, approximation, short maturity
JEL Classification: G13
Suggested Citation: Suggested Citation