Building Local Correlation Models for Analytical Pricing

Marcos Escobar-Anel

doi:10.20944/preprints202304.1011.v1

Preprint Communication Version 1 Preserved in Portico This version is not peer-reviewed

Version 1 : Received: 26 April 2023 / Approved: 27 April 2023 / Online: 27 April 2023 (03:22:51 CEST)

This short paper reveals a simple methodology to create local-correlation models suitable for the closed-form pricing of multi-asset financial derivatives. The multivariate models are built to ensure two conditions, first, marginals follow desirable processes, e.g. we choose the Geometric Brownian Motion (GBM), popular for stock prices. Second, the payoff of the derivative should follow a desired one dimensional process. These conditions lead to a specific choice of the dependence structure, in the form of a local-correlation model. Two popular multi-asset options are entertained, a spread option and a basket option.

local correlation; closed-form prices; spread option; basket option

Business, Economics and Management, Finance

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Building Local Correlation Models for Analytical Pricing

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