Valuing Exchange Options under an Ornstein-Uhlenbeck Covariance Model

Enrique Villamor () and Pablo Olivares
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Enrique Villamor: Department of Mathematics, Florida International University, Miami, FL 33199, USA
Pablo Olivares: Department of Mathematics, Toronto Metropolitan University, Toronto, ON M5B 2K3, Canada

IJFS, 2023, vol. 11, issue 2, 1-24

Abstract: In this paper we study the pricing of exchange options between two underlying assets whose dynamic show a stochastic correlation with random jumps. In particular, we consider a Ornstein-Uhlenbeck covariance model, with Levy Background Noise Processes driven by Inverse Gaussian subordinators. We use expansions in terms of Taylor polynomials and cubic splines to approximately compute the price of the derivative contract. Our findings show that the later approach provides an efficient way to compute the price when compared with a Monte Carlo method, while maintaining an equivalent degree of accuracy.

Keywords: exchange options; Ornstein-Uhlenbek; Taylor expansion; splines (search for similar items in EconPapers)
JEL-codes: F2 F3 F41 F42 G1 G2 G3 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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