Mathematical analysis of the two-color partial rainbow options |
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| Authors: | Der-Chen Chang Eric C Chang Haitao Fan Duy-Minh Nhieu |
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| Institution: | 1. Department of Mathematics , Georgetown University , Washington, DC 20057, USA chang@math.georgetown.edu;3. School of Business , Hong Kong University , Hong Kong;4. Department of Mathematics , Georgetown University , Washington, DC 20057, USA |
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| Abstract: | In this article, two-color partial rainbow options (TCPROs) are proposed. Such options allow holders to choose between the two underlying vanilla options at a specified time before expiry. Examples of benefits of TCPROs to both holders and issuers are given. Pricing formulae for such options are derived. The extra premium due to the choosing feature of a TCPRO, called the price of choice, is a nonnegative decreasing function of the correlation coefficient of the two underlying assets and the remaining time to choose. Numerical results are obtained to show that while TCPROs are more valuable than the underlying vanilla options, their risk parameters such as delta and gamma are smaller. |
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| Keywords: | Pricing Options Integral representation Two-color rainbow 1991 Mathematics Subject Classifications: 91B28 90A12 |
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