Abstract

https://ssrn.com/abstract=567021
 
 

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Valuing Exotic Derivatives with Jump Diffusions: The Case of Basket Options


Dimitris Flamouris


ABN Amro

Daniel Giamouridis


Bank of America - Bank of America Merrill Lynch; Athens University of Economics and Business; City University London - Cass Business School - Faculty of Finance; EDHEC Risk Institute

July 7, 2004


Abstract:     
Exotic options are complicated derivatives instruments whose structure does not allow, in general, for closed-form analytic solutions, thus, making their pricing and hedging a difficult task. To overcome additional complexity such products are, as a rule, priced within a Black-Scholes framework, assuming that the underlying asset follows a Geometric Brownian Motion (GBM) stochastic process. This paper develops a more realistic framework for the pricing of exotic derivatives; and derives closed-form analytic solutions for the pricing and hedging of basket options. We relax the simplistic assumption of the GBM, by introducing the Bernoulli Jump Diffusion process (BJD) and approximate the terminal distribution of the underlying asset with a log-normal distribution. Potential extension of the model with the use of the Edgeworth Series Expansion (ESE) is also discussed. Monte Carlo simulation confirms the validity of the proposed BJD model.

Number of Pages in PDF File: 28


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Date posted: July 23, 2004  

Suggested Citation

Flamouris, Dimitris and Giamouridis, Daniel, Valuing Exotic Derivatives with Jump Diffusions: The Case of Basket Options (July 7, 2004). Available at SSRN: https://ssrn.com/abstract=567021 or http://dx.doi.org/10.2139/ssrn.567021

Contact Information

Dimitris Flamouris
ABN Amro ( email )
250 Bishopsgate
London, NY EC2M 4AA
United Kingdom
+442076783158 (Phone)
Daniel Giamouridis (Contact Author)
Bank of America - Bank of America Merrill Lynch ( email )
United Kingdom
Athens University of Economics and Business ( email )
Department of Accounting and Finance
Greece
City University London - Cass Business School - Faculty of Finance ( email )
London, EC2Y 8HB
Great Britain
EDHEC Risk Institute ( email )
Lille
France
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