On the probability density function of baskets

DOI10.1007/978-3-319-11605-1_16zbMATH Open1418.91502arXiv1306.2793OpenAlexW1549605701MaRDI QIDQ4560341FDOQ4560341

Authors: Christian Bayer, Peter Friz, Peter Laurence 

Publication date: 11 December 2018

Published in: Springer Proceedings in Mathematics & Statistics (Search for Journal in Brave)

Abstract: The state price density of a basket, even under uncorrelated Black-Scholes dynamics, does not allow for a closed from density. (This may be rephrased as statement on the sum of lognormals and is especially annoying for such are used most frequently in Financial and Actuarial Mathematics.) In this note we discuss short time and small volatility expansions, respectively. The method works for general multi-factor models with correlations and leads to the analysis of a system of ordinary (Hamiltonian) differential equations. Surprisingly perhaps, even in two asset Black-Scholes situation (with its flat geometry), the expansion can degenerate at a critical (basket) strike level; a phenomena which seems to have gone unnoticed in the literature to date. Explicit computations relate this to a phase transition from a unique to more than one "most-likely" paths (along which the diffusion, if suitably conditioned, concentrates in the afore-mentioned regimes). This also provides a (quantifiable) understanding of how precisely a presently out-of-money basket option may still end up in-the-money.

Full work available at URL: https://arxiv.org/abs/1306.2793

Recommendations

• Small-time asymptotics for basket options -- the bivariate SABR model and the hyperbolic heat kernel on \(\mathbb{H}^3\)
• Asymptotics beats Monte Carlo: the case of correlated local vol baskets
• The pricing of basket-spread options
• General closed-form basket option pricing bounds
• Pricing of arithmetic basket options by conditioning.

zbMATH Keywords

focalitypricing of butterfly spreads on basketssums of lognormals

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Large deviations (60F10)

Cites Work

• A closed-form solution for options with stochastic volatility with applications to bond and currency options
• Application of large deviation methods to the pricing of index options in finance.
• Développement asymptotique du noyau de la chaleur hypoelliptique hors du cut-locus
• Title not available (Why is that?)
• Stock price distributions with stochastic volatility: an analytic approach
• Large deviations and the Malliavin calculus
• Title not available (Why is that?)
• Analytically tractable stochastic stock price models.
• Asymptotic behavior of the stock price distribution density and implied volatility in stochastic volatility models
• Marginal density expansions for diffusions and stochastic volatility. I: Theoretical foundations
• Methods de laplace et de la phase stationnaire sur l'espace de wiener
• DIFFUSION PROCESSES AND RIEMANNIAN GEOMETRY
• The log-normal approximation in financial and other computations
• Marginal density expansions for diffusions and stochastic volatility. II: Applications
• Title not available (Why is that?)
• Tail behavior of sums and differences of log-normal random variables

Cited In (5)

• Small-time asymptotics for basket options -- the bivariate SABR model and the hyperbolic heat kernel on \(\mathbb{H}^3\)
• A new concept of reliability system and applications in finance
• Reconstructing volatility: Pricing of index options under rough volatility
• Local Volatility, Conditioned Diffusions, and Varadhan's Formula
• Smoothing the payoff for efficient computation of Basket option prices

This page was built for publication: On the probability density function of baskets

Report a bug (only for logged in users!)Click here to report a bug for this page (MaRDI item Q4560341)