Communication
Version 1
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Building Local Correlation Models for Analytical Pricing
Version 1
: Received: 26 April 2023 / Approved: 27 April 2023 / Online: 27 April 2023 (03:22:51 CEST)
How to cite: Escobar-Anel, M. Building Local Correlation Models for Analytical Pricing. Preprints 2023, 2023041011. https://doi.org/10.20944/preprints202304.1011.v1 Escobar-Anel, M. Building Local Correlation Models for Analytical Pricing. Preprints 2023, 2023041011. https://doi.org/10.20944/preprints202304.1011.v1
Abstract
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.
Keywords
local correlation; closed-form prices; spread option; basket option
Subject
Business, Economics and Management, Finance
Copyright: This is an open access article distributed under the Creative Commons Attribution License which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.
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