A general closed-form spread option pricing formula |
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Authors: | Ruggero Caldana Gianluca Fusai |
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Affiliation: | 1. Dipartimento DiSei, Universita Studi del Piemonte Orientale, Via Perrone 18, 28100 Novara, Italy;2. Faculty of Finance, Cass Business School, City University London, 106 Bunhill Row, London EC1Y 8TZ, UK |
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Abstract: | 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. |
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Keywords: | C63 G13 |
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