Local Stochastic Correlation Models for Derivative Pricing

Marcos Escobar-Anel ()
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Marcos Escobar-Anel: Department of Statistical and Actuarial Sciences, Western University, 1151 Richmond Street, London, ON N6A 5B7, Canada
Authors registered in the RePEc Author Service: Marcos Escobar Anel ()

Stats, 2025, vol. 8, issue 3, 1-10

Abstract: This paper reveals a simple methodology to create local-correlation models suitable for the closed-form pricing of two-asset financial derivatives. The multivariate models are built to ensure two conditions. First, marginals follow desirable processes, e.g., we choose the Geometric Brownian Motion (GBM), popular for stock prices. Second, the payoff of the derivative should follow a desired one-dimensional process. These conditions lead to a specific choice of the dependence structure in the form of a local-correlation model. Two popular multi-asset options are entertained: a spread option and a basket option.

Keywords: local correlation; closed-form prices; spread option; basket option (search for similar items in EconPapers)
JEL-codes: C1 C10 C11 C14 C15 C16 (search for similar items in EconPapers)
Date: 2025
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