Pricing Product Options and Using Them to Complete Markets for Functions of Two Underlying Asset Prices

Dilip B. Madan and King Wang
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Dilip B. Madan: Robert H. Smith School of Business, University of Maryland, College Park, MD 20742, USA
King Wang: Derivative Product Strats, Morgan Stanley, 1585 Broadway, 5th Floor, New York, NY 10036, USA

JRFM, 2021, vol. 14, issue 8, 1-20

Abstract: Options paying the product of put and/or call option payouts at different strikes on two underlying assets are observed to synthesize joint densities and replicate differentiable functions of two underlying asset prices. The pricing of such options is undertaken from three perspectives. The first perspective uses a geometric two-dimensional Brownian motion model. The second inverts two-dimensional characteristic functions. The third uses a bootstrapped physical measure to propose a risk charge minimizing hedge using options on the two underlying assets. The options are priced at the cost of the hedge plus the risk charge.

Keywords: multivariate bilateral gamma; fast Fourier transform; distorted expectations; acceptable risks (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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