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Analytic approximation formulae for pricing forward‐starting Asian options
Author(s) -
Tsao ChuehYung,
Chang ChuangChang,
Lin ChungGee
Publication year - 2003
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.10070
Subject(s) - econometrics , economics , volatility (finance) , asian option , valuation of options , hedge , term (time) , mathematical economics , order (exchange) , financial economics , mathematics , finance , ecology , physics , quantum mechanics , biology
In this article we first identify a missing term in the Bouaziz, Briys, and Crouhy (1994) pricing formula for forward‐starting Asian options and derive the correctone. First, illustrate in certain cases that the missing term in their pricing formula could induce largepricing errors or unreasonable option prices. Second, we derive new analytic approximation formulae for valuingforward‐starting Asian options by adding the second‐order term in the Taylor series. We show thatour formulae can accurately value forward‐starting Asian options with a large underlying asset'svolatility or a longer time window for the average of the underlying asset prices, whereas the pricing errorsfor these options with the previously mentioned formula could be large. Third, we derive the hedge ratios forthese options and compare their properties with those of plain vanilla options. © 2003 Wiley Periodicals,Inc. Jrl Fut Mark 23:487–516, 2003