Bounds for Exotics

Abstract

Due to the complex structures of exotic options, it is difficult to derive exotic option pricing bounds using the conventional "no-arbitrage argument" approach. In this paper we present a new approach called the volatility bound approach to derive distribution and preference-free bounds on exotics. In particular, the bounds on Asian options, barrier options, and compound options are presented, with the possibility to extend to other exotic options. Further, we show that the bounds can provide many important insights which sharpen our understanding of those complex instruments.

Keywords: exotic option, risk management, model risk, option price

JEL Classification: G13