Spectral Expansions for Asian (Average Price) Options

Vadim Linetsky ()
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Vadim Linetsky: Department of Industrial Engineering and Management Sciences, McCormick School of Engineering and Applied Sciences, Northwestern University, 2145 Sheridan Road, Evanston, Illinois 60208

Operations Research, 2004, vol. 52, issue 6, 856-867

Abstract: Arithmetic Asian or average price options deliver payoffs based on the average underlying price over a prespecified time period. Asian options are an important family of derivative contracts with a wide variety of applications in currency, equity, interest rate, commodity, energy, and insurance markets. We derive two analytical formulas for the value of the continuously sampled arithmetic Asian option when the underlying asset price follows geometric Brownian motion. We use an identity in law between the integral of geometric Brownian motion over a finite time interval [0, t ] and the state at time t of a one-dimensional diffusion process with affine drift and linear diffusion and express Asian option values in terms of spectral expansions associated with the diffusion infinitesimal generator. The first formula is an infinite series of terms involving Whittaker functions M and W . The second formula is a single real integral of an expression involving Whittaker function W plus (for some parameter values) a finite number of additional terms involving incomplete gamma functions and Laguerre polynomials. The two formulas allow accurate computation of continuously sampled arithmetic Asian option prices.

Keywords: finance; asset pricing; option pricing; finance; securities; Asian (average price) options; probability; diffusion; average of geometric Brownian motion; spectral theory (search for similar items in EconPapers)
Date: 2004
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Citations: View citations in EconPapers (81)

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