QUANTO PRICING IN STOCHASTIC CORRELATION MODELS

Long Teng, Matthias Ehrhardt () and Michael Günther ()
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Long Teng: Lehrstuhl für Angewandte Mathematik und Numerische Analysis, Fakultät für Mathematik und Naturwissenschaften, Bergische Universität Wuppertal, Gaußstr.20, 42119 Wuppertal, Germany
Matthias Ehrhardt: Lehrstuhl für Angewandte Mathematik und Numerische Analysis, Fakultät für Mathematik und Naturwissenschaften, Bergische Universität Wuppertal, Gaußstr.20, 42119 Wuppertal, Germany
Michael Günther: Lehrstuhl für Angewandte Mathematik und Numerische Analysis, Fakultät für Mathematik und Naturwissenschaften, Bergische Universität Wuppertal, Gaußstr.20, 42119 Wuppertal, Germany

International Journal of Theoretical and Applied Finance (IJTAF), 2018, vol. 21, issue 05, 1-20

Abstract: Correlation plays an important role in pricing multi-asset options. In this work we incorporate stochastic correlation into pricing quanto options which is one special and important type of multi-asset option. Motivated by the market observations that the correlations between financial quantities behave like a stochastic process, instead of using a constant correlation, we allow the asset price process and the exchange rate process to be stochastically correlated with a parameter which is driven either by an Ornstein–Uhlenbeck process or a bounded Jacobi process. We derive an exact quanto option pricing formula in the stochastic correlation model of the Ornstein–Uhlenbeck process and a highly accurate approximated pricing formula in the stochastic correlation model of the bounded Jacobi process, where correlation risk has been hedged. The comparison between prices using our pricing formula and the Monte-Carlo method are provided.

Keywords: Quanto option; correlation risk; stochastic correlation process; characteristic function (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (2)

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DOI: 10.1142/S0219024918500383

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