Analytic approximation formulae for pricing forward-starting Asian options

✍ Scribed by Chueh-Yung Tsao; Chuang-Chang Chang; Chung-Gee Lin

• Publisher: John Wiley and Sons
• Year: 2003
• Tongue: English
• Weight: 190 KB
• Volume: 23
• Category: Article
• ISSN: 0270-7314
• DOI: 10.1002/fut.10070

✦ Synopsis

Abstract

In this article we first identify a missing term in the Bouaziz, Briys, and Crouhy (1994) pricing formula for forward‐starting Asian options and derive the correct
one. First, illustrate in certain cases that the missing term in their pricing formula could induce large
pricing errors or unreasonable option prices. Second, we derive new analytic approximation formulae for valuing
forward‐starting Asian options by adding the second‐order term in the Taylor series. We show that
our formulae can accurately value forward‐starting Asian options with a large underlying asset's
volatility or a longer time window for the average of the underlying asset prices, whereas the pricing errors
for these options with the previously mentioned formula could be large. Third, we derive the hedge ratios for
these options and compare their properties with those of plain vanilla options. © 2003 Wiley Periodicals,
Inc. Jrl Fut Mark 23:487–516, 2003