On the qualitative effect of volatility and duration on prices of Asian options

Peter Carr, Christian-Oliver Ewald and Yajun Xiao

Finance Research Letters, 2008, vol. 5, issue 3, 162-171

Abstract: We show that under the Black-Scholes assumption the price of an arithmetic average Asian call option with fixed strike increases with the level of volatility. This statement is not trivial to prove and for other models in general wrong. In fact we demonstrate that in a simple binomial model no such relationship holds. Under the Black-Scholes assumption however, we give a proof based on the maximum principle for parabolic partial differential equations. Furthermore we show that an increase in the length of duration over which the average is sampled also increases the price of an arithmetic average Asian call option, if the discounting effect is taken out. To show this, we use the result on volatility and the fact that a reparametrization in time corresponds to a change in volatility in the Black-Scholes model. Both results are extremely important for the risk management and risk assessment of portfolios that include Asian options.

Keywords: Asian; options; Volatility; Vega; Duration; Qualitative; risk-management (search for similar items in EconPapers)
Date: 2008
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Citations: View citations in EconPapers (12)

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