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A note on the valuation of compound options

Fatma Lajeri‐Chaherli

Journal of Futures Markets, 2002, vol. 22, issue 11, 1103-1115

Abstract: The value of a compound option, an option on an option, has been derived by Geske (1976) using Fourier integrals. This article presents two alternative proofs to derive the value of a compound option. One proof is based on the martingale approach, which provides a simple and powerful tool for valuing contingent claims. The second proof uses the expectation of a truncated bivariate normal variable. These proofs allow for an intuitive interpretation of the three elements constituting the value of a compound option. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:1103–1115, 2002

Date: 2002
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