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Correlation Risk Premia for Multi-Asset Equity Options

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  • Fengler, Matthias R.
  • Schwendner, Peter

Abstract

The lack of a liquid market for implied correlations requires traders to estimate correlation matrices for pricing multi-asset equity options from historical data. To quantify the precision of these correlation estimates, we devise a block bootstrap procedure. The resulting bootstrap distributions are mapped on price distributions of three standard types of multi-asset options. ?Minimal? bid-ask spreads that reflect the risk from estimating the unknown correlations are quoted as quantiles of the price distributions. We discuss the influence of different market regimes and different payoff structures on the price distributions and on the the size of the resulting bid-ask spreads.

Suggested Citation

  • Fengler, Matthias R. & Schwendner, Peter, 2003. "Correlation Risk Premia for Multi-Asset Equity Options," SFB 373 Discussion Papers 2003,10, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
    • Handle: RePEc:zbw:sfb373:200310
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    References listed on IDEAS

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    1. Turan G. Bali & Hans Genberg & Salih N. Neftci, 2002. "Excessive variation in risk‐factor correlations and volatilities," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 22(12), pages 1119-1146, December.
    2. Johnson, Herb, 1987. "Options on the Maximum or the Minimum of Several Assets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(3), pages 277-283, September.
    3. Fengler, Matthias R. & Herwartz, Helmut, 2001. "Multivariate volatility models," SFB 373 Discussion Papers 2001,74, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
    4. Margrabe, William, 1978. "The Value of an Option to Exchange One Asset for Another," Journal of Finance, American Finance Association, vol. 33(1), pages 177-186, March.
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    Cited by:

    1. Aydınlı, Gökhan & Härdle, Wolfgang Karl & Neuwirth, E., 2003. "Computational Statistics with Spreadsheets Towards Efficiency, Reproducibility and Security," SFB 373 Discussion Papers 2003,26, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
    2. Pellegrino, Tommaso & Sabino, Piergiacomo, 2014. "On the use of the moment-matching technique for pricing and hedging multi-asset spread options," Energy Economics, Elsevier, vol. 45(C), pages 172-185.
    3. Farnaz Farzan & Khashayar Mahani & Kaveh Gharieh & Mohsen Jafari, 2015. "Microgrid investment under uncertainty: a real option approach using closed form contingent analysis," Annals of Operations Research, Springer, vol. 235(1), pages 259-276, December.

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