Mathematical analysis of the two-color partial rainbow options

In this article, two-color partial rainbow options (TCPROs) are proposed. Such options allow holders to choose between the two underlying vanilla options at a specified time before expiry. Examples of benefits of TCPROs to both holders and issuers are given. Pricing formulae for such options are der...

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Bibliographic Details
Published in:Applicable analysis 2005-07, Vol.84 (7), p.737-757
Main Authors: Chang, Der-Chen, Chang, Eric C., Fan, Haitao, Nhieu, Duy-Minh
Format: Article
Language:English
Subjects:
1991 Mathematics Subject Classifications
Integral representation
Options
Pricing
Two-color rainbow
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Summary:In this article, two-color partial rainbow options (TCPROs) are proposed. Such options allow holders to choose between the two underlying vanilla options at a specified time before expiry. Examples of benefits of TCPROs to both holders and issuers are given. Pricing formulae for such options are derived. The extra premium due to the choosing feature of a TCPRO, called the price of choice, is a nonnegative decreasing function of the correlation coefficient of the two underlying assets and the remaining time to choose. Numerical results are obtained to show that while TCPROs are more valuable than the underlying vanilla options, their risk parameters such as delta and gamma are smaller.
ISSN:0003-6811
1563-504X
DOI:10.1080/00036810500047774