An Average Problem（373-393）.pdfVIP

Exotic Derivatives 15 An Average Problem Key words: Edgeworth expansions, Fourier and Laplace transforms, PDE, exotic options In this chapter, we describe and compare alternative procedures for pricing Asian options. Asian options are written on an average. More precisely, prices of an un- derlying security (or index) are recorded on a set of dates during the lifetime of the contract. At the option’s maturity, a pay-off is computed as a deterministic function of an average of these prices (see Carr and Schröder (2004)). As reported by Falloon and Turner (1999), the first contract linked to an average price was traded in 1987 by Bankers Trust in Tokyo, hence the attribute “Asian”. Asian options are quite popular among derivative traders and risk managers. This is due to several reasons. Primarily, Asian options smooth possible market manipu- lations occurring near the expiry date. They also provide a suitable hedge for firms facing a stream of cashflows. This is the case, for instance, with commodity end- users that are financially exposed to average prices. The standard Asian contract is written on the arithmetic average of an asset price or any financial index computed across weekly (or monthly) observations. It is a common practice to price this contract computing this average on a set of values recorded continuously over the option lifetime. In the standard Black–Scholes frame- work, the average depends on a sum of correlated lognormal variates. Unfortunately, the distribution of this sum does not admit a simple analytical expression. Conse- quently, numerical approximations need to be developed for the purpose of pricing arithmetic Asian options (Kat (2001)). This case illustrates and compares the following methods: (a) Approximation of the average distribution by fitting integer moments (Turnbull and Wakeman (1991), Levy (1992), Milevsky and Posner (1998) and Ju (2002)). (b) Computation of lower and upper bounds