A general closed-form spread option pricing formula

Caldana, R. & Fusai, G. (2013). A general closed-form spread option pricing formula. Journal of Banking & Finance, 37(12), pp. 4893-4906. doi: 10.1016/j.jbankfin.2013.08.016

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We propose a new accurate method for pricing European spread options by extending the lower bound approximation of Bjerksund and Stensland (2011) beyond the classical Black–Scholes framework. This is possible via a procedure requiring a univariate Fourier inversion. In addition, we are also able to obtain a new tight upper bound. Our method provides also an exact closed form solution via Fourier inversion of the exchange option price, generalizing the Margrabe (1978) formula. The method is applicable to models in which the joint characteristic function of the underlying assets forming the spread is known analytically. We test the performance of these new pricing algorithms performing numerical experiments on different stochastic dynamic models.

Item Type: Article
Additional Information: NOTICE: this is the author’s version of a work that was accepted for publication in Journal of Banking & Finance. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Journal of Banking & Finance, Volume 37, Issue 12, December 2013, http://dx.doi.org/10.1016/j.jbankfin.2013.08.016
Uncontrolled Keywords: Spread option; Exchange option; Stochastic process; Characteristic function; Fourier inversion; Control variate
Subjects: H Social Sciences > HG Finance
Divisions: Cass Business School > Faculty of Finance
Related URLs:
URI: http://openaccess.city.ac.uk/id/eprint/5993

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