Basket options on heterogeneous underlying assets

Georges Dionne (), Geneviève Gauthier () and Nadia Ouertani ()
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Geneviève Gauthier: HEC Montreal, Department of Decision Sciences
Nadia Ouertani: HEC Montreal, Canada Research Chair in Risk Management

No 09-3, Working Papers from HEC Montreal, Canada Research Chair in Risk Management

Abstract: Basket options are among the most popular products of the new generation of exotic options. This attraction is explained by the fact that they can e¢ ciently and simultaneously hedge a wide variety of intrinsically di§erent Önancial risks. They are áexible enough to include all the risks faced by non-Önancial Örms. Unfortunately, the existing literature on basket options considers only homogeneous baskets where all the underlying assets are identical and hedge the same kind of risk. Moreover, the empirical implementation of basket-option models is not yet well developed, particularly when they are composed of heterogeneous underlying assets. This paper focus on the modelization and the parameters estimation of basket options on commodity price with stochastic convenience yield, exchange rate, and domestic and foreign zero-coupon bonds in a stochastic interest rates setting. We empirically compare the performance of the heterogeneous basket option to that of a portfolio of individual options. The results show that the basket strategy is less expensive and more e¢ cient. We apply the maximum-likelihood method to estimate the di§erent parameters of the theoretical basket model as well as the correlations between the variables. Monte Carlo studies are conducted to examine the performance of the maximum likelihood estimator in finite samples of simulated data. A real data study is presented.

Keywords: Basket options; maximum likelihood; hedging performance; options pricing; Monte Carlo simulation (search for similar items in EconPapers)
JEL-codes: C15 C16 G10 G13 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2009-05-19
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Working Paper: Basket Options on Heterogeneous Underlying Assets (2009)
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