The British Asian Option

Kristoffer Glover, Goran Peskir and Farman Samee

No 249, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: Following the economic rationale of [7] and [8] we present a new class of Asian options where the holder enjoys the early exercise feature of American options whereupon his payoff (deliverable immediately) is the ‘best prediction’ of the European payoff under the hypothesis that the true drift of the stock price equals a contract drift. Inherent in this is a protection feature which is key to the British Asian option. Should the option holder believe the true drift of the stock price to be unfavourable (based upon the observed price movements) he can substitute the true drift with the contract drift and minimise his losses. The practical implications of this protection feature are most remarkable as not only is the option holder afforded a unique protection against unfavourable stock price movements (covering the ability to sell in a liquid market completely endogenously) but also when the stock price movements are favourable he will generally receive high returns. We derive a closed form expression for the arbitrage-free price in terms of the rational exercise boundary and show that the rational exercise boundary itself can be characterised as the unique solution to a nonlinear integral equation. Using these results we perform a financial analysis of the British Asian option that leads to the conclusions above and shows that with the contract drift properly selected the British Asian option becomes a very attractive alternative to the classic (European) Asian option.

Keywords: British Asian option; American Asian option; European Asian option; fixed/floating strike; arithmetic/geometric average; flexible Asian options; arbitrage-free price; rational exercise boundary; liquid/illiquid market; geometric Brownian motion; the Shiryaev process; optimal stopping, parabolic free-boundary problem; nonlinear integral equation; local time-space calculus (search for similar items in EconPapers)
Pages: 17 pages
Date: 2009-05-01
References: Add references at CitEc
Citations: View citations in EconPapers (5)

Published as: Glover, K., Peskir, G. and Samee, F., 2010, "The British Asian Option", Sequential Analysis: Design Methods and Applications, 29(3), 311-327.

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