The hexanomial lattice for pricing multi-asset options

Multi-asset options are important financial derivatives. Because closed-form solutions do not exist for most of them, numerical alternatives such as lattice are mandatory. But lattices that require the correlation between assets to be confined to a narrow range will have limited uses. Let ρij denote...

Full description

Saved in:
Bibliographic Details
Published in:Applied mathematics and computation 2014-05, Vol.233, p.463-479
Main Authors: Kao, Wen-Hung, Lyuu, Yuh-Dauh, Wen, Kuo-Wei
Format: Article
Language:English
Subjects:
Barrier option
Binomial lattice
Correlation
Hexanomial lattice
Multi-asset option
Trinomial lattice
Citations: Items that this one cites
Items that cite this one
Online Access:Get full text
Tags: Add Tag
No Tags, Be the first to tag this record!
Description
Summary:Multi-asset options are important financial derivatives. Because closed-form solutions do not exist for most of them, numerical alternatives such as lattice are mandatory. But lattices that require the correlation between assets to be confined to a narrow range will have limited uses. Let ρij denote the correlation between assets i and j. This paper defines a (correlation) optimal lattice as one that guarantees validity as long as -1+O(Δt)⩽ρij⩽1-O(Δt) for all pairs of assets i and j, where Δt is the duration of a time period. This paper then proposes the first optimal bivariate lattice (generalizable to higher dimensions), called the hexanomial lattice. This lattice furthermore has the flexibility to handle a barrier on each asset. Experiments confirm its excellent numerical performance compared with alternative lattices.
ISSN:0096-3003
1873-5649
DOI:10.1016/j.amc.2014.01.173