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Pricing Of Traffic Light Options And Other Hybrid Products

Author

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  • THOMAS KOKHOLM

    (Finance Research Group, Department of Business Studies, Aarhus School of Business, Aarhus University, Fuglesangs Allé 4, Aarhus V, 8210, Denmark)

Abstract

This paper considers derivatives with payoffs that depend on a stock index and underlying LIBOR rates. A traffic light option pricing formula is derived under lognormality assumptions on the underlying processes. The traffic light option is aimed at the Danish life and pension sector to help companies stay solvent in the traffic light stress test system introduced by the Danish Financial Supervisory Authorities in 2001. Similar systems are now being implemented in several other European countries. A pricing approach for general payoffs is presented and illustrated with simulation via the pricing of a hybrid derivative known as the EUR Sage Note. The approach can be used to price many existing structured products.

Suggested Citation

  • Thomas Kokholm, 2009. "Pricing Of Traffic Light Options And Other Hybrid Products," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 12(05), pages 687-707.
    • Handle: RePEc:wsi:ijtafx:v:12:y:2009:i:05:n:s0219024909005415
    DOI: 10.1142/S0219024909005415
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    Cited by:

    1. Michael Schmutz & Thomas Zürcher, 2014. "Static Hedging with Traffic Light Options," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 34(7), pages 690-702, July.
    2. Michael Schmutz & Thomas Zurcher, 2010. "Static replications with traffic light options," Papers 1011.4795, arXiv.org.

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