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On the qualitative effect of volatility and duration on prices of Asian options

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  • Carr, Peter
  • Ewald, Christian-Oliver
  • Xiao, Yajun

Abstract

We show that under the Black-Scholes assumption the price of an arithmetic average Asian call option with fixed strike increases with the level of volatility. This statement is not trivial to prove and for other models in general wrong. In fact we demonstrate that in a simple binomial model no such relationship holds. Under the Black-Scholes assumption however, we give a proof based on the maximum principle for parabolic partial differential equations. Furthermore we show that an increase in the length of duration over which the average is sampled also increases the price of an arithmetic average Asian call option, if the discounting effect is taken out. To show this, we use the result on volatility and the fact that a reparametrization in time corresponds to a change in volatility in the Black-Scholes model. Both results are extremely important for the risk management and risk assessment of portfolios that include Asian options.

Suggested Citation

  • Carr, Peter & Ewald, Christian-Oliver & Xiao, Yajun, 2008. "On the qualitative effect of volatility and duration on prices of Asian options," Finance Research Letters, Elsevier, vol. 5(3), pages 162-171, September.
    • Handle: RePEc:eee:finlet:v:5:y:2008:i:3:p:162-171
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    References listed on IDEAS

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    1. Eric Fournié & Jean-Michel Lasry & Pierre-Louis Lions & Jérôme Lebuchoux & Nizar Touzi, 1999. "Applications of Malliavin calculus to Monte Carlo methods in finance," Finance and Stochastics, Springer, vol. 3(4), pages 391-412.
    2. Hélyette Geman & Marc Yor, 1993. "Bessel Processes, Asian Options, And Perpetuities," Mathematical Finance, Wiley Blackwell, vol. 3(4), pages 349-375, October.
    3. Jagannathan, Ravi, 1984. "Call options and the risk of underlying securities," Journal of Financial Economics, Elsevier, vol. 13(3), pages 425-434, September.
    4. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
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    Cited by:

    1. Ewald, Christian Oliver & Taub, Bart, 2022. "Real options, risk aversion and markets: A corporate finance perspective," Journal of Corporate Finance, Elsevier, vol. 72(C).
    2. Jan Vecer, 2013. "Asian options on the harmonic average," Quantitative Finance, Taylor & Francis Journals, vol. 14(8), pages 1315-1322, September.
    3. Bogso, Antoine Marie, 2015. "MRL order, log-concavity and an application to peacocks," Stochastic Processes and their Applications, Elsevier, vol. 125(4), pages 1282-1306.
    4. Chung, Shing Fung & Wong, Hoi Ying, 2014. "Analytical pricing of discrete arithmetic Asian options with mean reversion and jumps," Journal of Banking & Finance, Elsevier, vol. 44(C), pages 130-140.
    5. Zhaojun Yang & Christian-Oliver Ewald & Olaf Menkens, 2011. "Pricing and hedging of Asian options: quasi-explicit solutions via Malliavin calculus," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 74(1), pages 93-120, August.
    6. Ewald, Christian-Oliver & Yor, Marc, 2015. "On increasing risk, inequality and poverty measures: Peacocks, lyrebirds and exotic options," Journal of Economic Dynamics and Control, Elsevier, vol. 59(C), pages 22-36.
    7. Dan Pirjol & Lingjiong Zhu, 2018. "Sensitivities Of Asian Options In The Black–Scholes Model," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 21(01), pages 1-25, February.
    8. Ting, Sai Hung Marten & Ewald, Christian-Oliver & Wang, Wen-Kai, 2013. "On the investment–uncertainty relationship in a real option model with stochastic volatility," Mathematical Social Sciences, Elsevier, vol. 66(1), pages 22-32.
    9. Dan Pirjol & Lingjiong Zhu, 2016. "Short Maturity Asian Options in Local Volatility Models," Papers 1609.07559, arXiv.org.
    10. Liu, Yating & Pagès, Gilles, 2022. "Monotone convex order for the McKean–Vlasov processes," Stochastic Processes and their Applications, Elsevier, vol. 152(C), pages 312-338.
    11. Dan Pirjol & Lingjiong Zhu, 2023. "Sensitivities of Asian options in the Black-Scholes model," Papers 2301.06460, arXiv.org.
    12. Ewald, Christian-Oliver & Menkens, Olaf & Hung Marten Ting, Sai, 2013. "Asian and Australian options: A common perspective," Journal of Economic Dynamics and Control, Elsevier, vol. 37(5), pages 1001-1018.

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