Rainbow trend options: valuation and applications

Jr-Yan Wang (), Hsiao-Chuan Wang (), Yi-Chen Ko () and Mao-Wei Hung ()
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Jr-Yan Wang: National Taiwan University
Hsiao-Chuan Wang: National Taiwan University
Yi-Chen Ko: National Taiwan University
Mao-Wei Hung: National Taiwan University

Review of Derivatives Research, 2017, vol. 20, issue 2, No 1, 133 pages

Abstract: Abstract Asset selection and timing decisions are major investment concerns. To resolve these issues simultaneously, a new class of rainbow trend options is proposed. The diversification effect of rainbow options can reduce the importance of asset selection decisions and trend options can mitigate unfavorable effects on market entry and exit decisions. We consider a general framework to facilitate the derivation of analytic pricing formulas for simple, pure, and Asian rainbow trend options using the martingale pricing method. The properties of these options and their Greeks are analyzed. We also investigate the performance of the dynamic delta hedging strategy for issuers of rainbow trend options. Last, this paper explores the applications of rainbow trend options for hedging price risks, designing executive stock options, modifying countercyclical capital buffer proposed by Basel Committee, and acting as control variates of the Monte Carlo simulation.

Keywords: Rainbow option; Trend option; Timing risk; Asset selection; Martingale pricing method (search for similar items in EconPapers)
JEL-codes: G13 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (2)

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DOI: 10.1007/s11147-016-9125-z

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