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Multi-asset spread option pricing and hedging

By Minqiang Li, Jieyun Zhou and Shi-Jie Deng

Abstract

We provide two new closed-form approximation methods for pricing spread options on a basket of risky assets: the extended Kirk approximation and the second-order boundary approximation. The latter method generalizes the results in Li et al. [J. Deriv., 2008, 15, 58-80] to spread options on an arbitrary number of assets. Numerical analysis shows that while the latter method is more accurate than the former, both methods are extremely fast and accurate. Closed-form approximations for important Greeks are also derived. Our approximation methods enable the accurate pricing of a bulk volume of spread options on a large number of assets in real time, which offers traders a potential edge in a dynamic market environment.Multi-asset spread options, Second-order boundary approximation, Closed-form approximation,

DOI identifier: 10.1080/14697680802626323
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