An approximation formula for basket option prices under local stochastic volatility with jumps: an application to commodity markets

Kenichiro Shiraya and Akihiko Takahashi
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Kenichiro Shiraya: The University of Tokyo
Akihiko Takahashi: The University of Tokyo

No CARF-F-361, CARF F-Series from Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo

Abstract: This paper develops a new approximation formula for pricing basket options in a local-stochastic volatility model with jumps. In particular, the model admits local volatility functions and jump components in not only the underlying asset price processes, but also the volatility processes. To the best of our knowledge, the proposed formula is the first one which achieves an analytical approximation for the basket option prices under this type of the models. Moreover, in numerical experiments, we provide approximate prices for basket options on the WTI futures and Brent futures based on the parameters through calibration to the plain-vanilla option prices, and confirm the validity of our approximation formula.

Pages: 39 pages
Date: 2015-05, Revised 2015-08
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:cfi:fseres:cf361

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