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Evaluation of analytical approximations of two-asset basket option price

Nilsson, Teo LU (2015) NEKN01 20151
Department of Economics
Abstract
This thesis applies the decomposition suggested by Alexander and Venkatramanan (2012) to the pay-off of a basket option of two assets with a non-zero strike to derive an approximate price of corresponding basket option. The decomposition yields two sub-baskets and a situation where sub-strikes must be chosen. Approximation errors are studied for different sub-strikes and whenever possible, a rule of thumb is given. Furthermore, the approximation is evaluated against Monte Carlo simulations for a wide range of parameters. Finally, the approximation is benchmarked against the well renowned approximation suggested by Ju (2002) based on Taylor expansion around zero-volatility. It is concluded that the approximation suggested by Alexander and... (More)
This thesis applies the decomposition suggested by Alexander and Venkatramanan (2012) to the pay-off of a basket option of two assets with a non-zero strike to derive an approximate price of corresponding basket option. The decomposition yields two sub-baskets and a situation where sub-strikes must be chosen. Approximation errors are studied for different sub-strikes and whenever possible, a rule of thumb is given. Furthermore, the approximation is evaluated against Monte Carlo simulations for a wide range of parameters. Finally, the approximation is benchmarked against the well renowned approximation suggested by Ju (2002) based on Taylor expansion around zero-volatility. It is concluded that the approximation suggested by Alexander and Venkatramanan (2012) is highly dependent on the property of being in the money and is sometimes preferred over the approximation suggested by Ju (2002). (Less)
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author
Nilsson, Teo LU
supervisor
organization
course
NEKN01 20151
year
type
H1 - Master's Degree (One Year)
subject
keywords
Teo, Nilsson, Basket-option, Option-pricing, Analytical-approximation
language
English
id
5466046
date added to LUP
2015-06-30 10:54:48
date last changed
2015-06-30 10:54:48
@misc{5466046,
  abstract     = {This thesis applies the decomposition suggested by Alexander and Venkatramanan (2012) to the pay-off of a basket option of two assets with a non-zero strike to derive an approximate price of corresponding basket option. The decomposition yields two sub-baskets and a situation where sub-strikes must be chosen. Approximation errors are studied for different sub-strikes and whenever possible, a rule of thumb is given. Furthermore, the approximation is evaluated against Monte Carlo simulations for a wide range of parameters. Finally, the approximation is benchmarked against the well renowned approximation suggested by Ju (2002) based on Taylor expansion around zero-volatility. It is concluded that the approximation suggested by Alexander and Venkatramanan (2012) is highly dependent on the property of being in the money and is sometimes preferred over the approximation suggested by Ju (2002).},
  author       = {Nilsson, Teo},
  keyword      = {Teo,Nilsson,Basket-option,Option-pricing,Analytical-approximation},
  language     = {eng},
  note         = {Student Paper},
  title        = {Evaluation of analytical approximations of two-asset basket option price},
  year         = {2015},
}