Sharp Upper and Lower Bounds for Basket Options

Peter Laurence and Tai-Ho Wang

Applied Mathematical Finance, 2005, vol. 12, issue 3, 253-282

Abstract: Given a basket option on two or more assets in a one-period static hedging setting, the paper considers the problem of maximizing and minimizing the basket option price subject to the constraints of known option prices on the component stocks and consistency with forward prices and treat it as an optimization problem. Sharp upper bounds are derived for the general n-asset case and sharp lower bounds for the two-asset case, both in closed forms, of the price of the basket option. In the case n = 2 examples are given of discrete distributions attaining the bounds. Hedge ratios are also derived for optimal sub and super replicating portfolios consisting of the options on the individual underlying stocks and the stocks themselves.

Keywords: Basket option; duality; sharp bound (search for similar items in EconPapers)
Date: 2005
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Citations: View citations in EconPapers (26)

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DOI: 10.1080/1350486042000325179

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