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An Efficient Unified Approach for Spread Option Pricing in a Copula Market Model

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  • Edoardo Berton
  • Lorenzo Mercuri

Abstract

In this study, we propose a new formula for spread option pricing with the dependence of two assets described by a copula function. The advantage of the proposed method is that it requires only the numerical evaluation of a one-dimensional integral. Any univariate stock price process, admitting an affine characteristic function, can be used in our formula to get an efficient numerical procedure for computing spread option prices. In the numerical analysis we present a comparison with Monte Carlo simulation methods to assess the performance of our approach, assuming that the univariate stock price follows three widely applied models: Variance Gamma, Heston's Stochastic Volatility and Affine Heston Nandi GARCH(1,1) model.

Suggested Citation

  • Edoardo Berton & Lorenzo Mercuri, 2021. "An Efficient Unified Approach for Spread Option Pricing in a Copula Market Model," Papers 2112.11968, arXiv.org, revised Feb 2023.
    • Handle: RePEc:arx:papers:2112.11968
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    References listed on IDEAS

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    1. Christoffersen, Peter & Heston, Steve & Jacobs, Kris, 2006. "Option valuation with conditional skewness," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 253-284.
    2. Caldana, Ruggero & Fusai, Gianluca, 2013. "A general closed-form spread option pricing formula," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 4893-4906.
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    7. Mercuri, Lorenzo, 2008. "Option pricing in a Garch model with tempered stable innovations," Finance Research Letters, Elsevier, vol. 5(3), pages 172-182, September.
    8. Heston, Steven L, 1993. "A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options," The Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 327-343.
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    13. Heston, Steven L & Nandi, Saikat, 2000. "A Closed-Form GARCH Option Valuation Model," The Review of Financial Studies, Society for Financial Studies, vol. 13(3), pages 585-625.
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    Cited by:

    1. Roza Galeeva & Zi Wang, 2024. "Sector Formula for Approximation of Spread Option Value & Greeks and Its Applications," Commodities, MDPI, vol. 3(3), pages 1-33, July.

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