The closed-form approximation to price basket options under stochastic interest rate

Bo Yu, Hongmei Zhu and Ping Wu

Finance Research Letters, 2022, vol. 46, issue PB

Abstract: The paper presents closed-form approximation formulas for pricing basket options. We assume that the underlying asset prices follow geometric Brownian motions and the interest rate follows the one-factor Hull-White model. Under a given forward measure, we obtain the analytical lower and upper bounds of basket options. By finding a simple random variable to replace the sum of the lognormal random variables, we combine the conditioning and the moment matching approaches, and derive approximation formulas to price basket options. Numerical results illustrate that our results fall in the sharp lower and upper bounds of basket options and are consistent with Monte Carlo simulation results.

Keywords: Basket options; Forward valuation method; Log-normal distribution; Moment matching approach; Conditioning approach (search for similar items in EconPapers)
JEL-codes: C63 G13 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:46:y:2022:i:pb:s1544612321004232

DOI: 10.1016/j.frl.2021.102434

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