A general closed-form spread option pricing formula

Ruggero Caldana and Gianluca Fusai

Journal of Banking & Finance, 2013, vol. 37, issue 12, 4893-4906

Abstract: We propose a new accurate method for pricing European spread options by extending the lower bound approximation of Bjerksund and Stensland (2011) beyond the classical Black–Scholes framework. This is possible via a procedure requiring a univariate Fourier inversion. In addition, we are also able to obtain a new tight upper bound. Our method provides also an exact closed form solution via Fourier inversion of the exchange option price, generalizing the Margrabe (1978) formula. The method is applicable to models in which the joint characteristic function of the underlying assets forming the spread is known analytically. We test the performance of these new pricing algorithms performing numerical experiments on different stochastic dynamic models.

Keywords: Spread option; Exchange option; Stochastic process; Characteristic function; Fourier inversion; Control variate (search for similar items in EconPapers)
JEL-codes: C63 G13 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (36)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:37:y:2013:i:12:p:4893-4906

DOI: 10.1016/j.jbankfin.2013.08.016

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