Spanning and derivative-security valuation

Spanning and derivative-security valuation This article provides the economic foundations for valuing derivative securities. In particular, it establishes how the characteristic function (of the future uncertainty) is basis augmenting and spans the payoff universe of most, if not all, derivative assets. From the characteristic function of the state-price density, it is possible to analytically price options on any arbitrary transformation of the underlying uncertainty. By differentiating (or translating) the characteristic function, limitless pricing and/or spanning opportunities can be designed. The strength and versatility of the methodology is inherent when valuing (1) average-interest options, (2) correlation options, and (3) discretely monitored knock-out options. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Financial Economics Elsevier

Spanning and derivative-security valuation

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Publisher
Elsevier
Copyright
Copyright © 2000 Elsevier Science B.V.
ISSN
0304-405x
D.O.I.
10.1016/S0304-405X(99)00050-1
Publisher site
See Article on Publisher Site

Abstract

This article provides the economic foundations for valuing derivative securities. In particular, it establishes how the characteristic function (of the future uncertainty) is basis augmenting and spans the payoff universe of most, if not all, derivative assets. From the characteristic function of the state-price density, it is possible to analytically price options on any arbitrary transformation of the underlying uncertainty. By differentiating (or translating) the characteristic function, limitless pricing and/or spanning opportunities can be designed. The strength and versatility of the methodology is inherent when valuing (1) average-interest options, (2) correlation options, and (3) discretely monitored knock-out options.

Journal

Journal of Financial EconomicsElsevier

Published: Feb 1, 2000

References

  • Bessel processes, Asian options and perpetuities
    Geman, H.; Yor, M.
  • Fourier Transforms
    Goldberg, R.
  • The pricing of options on assets with stochastic volatilities
    Hull, J.; White, A.
  • Interest rate volatility and the term structure: a two-factor general equilibrium model
    Longstaff, F.; Schwartz, E.

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