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We study the numerical solution of the Greeks asian option monte carlo Asian options. In particular, we derive a close form solution of of Asian geometric option and use this analytical form as a control to numerically calculate of Asian arithmetic option, which is known to have no explicit close form solution.
We implement our proposed numerical method and compare asian option monte carlo standard error with other classical variance reduction methods. Our method provides an efficient solution to the hedging strategy with Asian options.
Asian options are referred to as securities with payoffs that depend on the average of the underlying stock price over a time interval. It got its name aroundwhen David Spaughton and Mark Standish worked for Bankers Trust in Tokyo, where they developed the first commercially used pricing formula for options linked to the average price of crude oil.
Asian options have appealing features that attract many investors. For example, end-users of energies or commodities tend to be exposed to the average prices over time, so Asian options suit their needs.
Asian options are also popular among international corporations, who have ongoing currency exposures. Asian options tend to be less expensive than comparable Vanilla options, since the volatility in the average value of the underlying asset tends to be less than its spot value.
Asian options also reduce the risk of price manipulation of underlying asset that is thinly traded. The payoff of Asian arithmetic average call option with strike price is given by Since no analytical solution is known, a variety of numerical approximation techniques have been developed to analyze the Asian arithmetic average option.
Many authors are devoted to the numerical approximation of the close form formula see Turnbull and Wakeman [ 2 ], Vorst [ 3 ], Levy [ 4 ], and Levy and Turnbull [ 5 ]. Monte Carlo simulation could be a nice approach see Broadie and Glasserman [ 6 ] and Kemna and Vorst [ 7 ]but it can be computational expensive without variation reduction method.
It should also be noted that the discretization of the continuous process could introduce errors see Broadie et al. Once the approximated pricing formula for the Asian arithmetic option is available, one can obtain the Greeks by applying a shock on the underlying asset price with the finite difference methods. In this paper, we study asian option monte carlo Greeks of Asian arithmetic call option.
In particular, we will implement a numerical scheme to compute of Asian arithmetic call option, by Monte Carlo method with a control variate. Asian option monte carlo Section 3we briefly introduce the general principle of Monte Carlo method with some variance reduction techniques. In Section 4we derive a close form pricing formula for the Asian geometric average call option. As a consequence, we obtain an analytical formula for of Asian geometric average call option, which will be used as a control variate in the Monte Carlo simulation.
In the last asian option monte carlo, we describe the numerical scheme asian option monte carlo compute of Asian arithmetic average call option and compare our results asian option monte carlo other variance reduction techniques.
The Monte Carlo method can be used to price a wide range of exotic options as well as to analyze their Greeks, especially when the close form solutions do not exist. However, due to the reason of biased estimation and high computation cost, many modified Monte Carlo methods were proposed to estimate the Greeks by simulation.
Broadie and Glasserman [ 6 ] developed a method called infinitesimal perturbation analysis, which is based on the relationship between the payoffs and the Greeks of interest. Unlike the infinitesimal perturbation analysis, asian option monte carlo likelihood ratio method is based on the probability density function of underlying price and the Greeks. Both methods mentioned above provide unbiased estimators but differ in applicability and effectiveness.
In order to reduce the variance of the estimators, many techniques have been asian option monte carlo. The most effective variance reduction technique is the control variate method.
In the case of Asian option, the payoff of geometric Asian option is set to be a control variate in order to improve the effectiveness of the payoffs of algorithm Asian option prices.
Other methods include analytic method and finite difference approach. See Boyle and Potapchik [ asian option monte carlo ] for an extensive survey of relevant literature. Nowadays the advance of financial engineering has introduced lots of demands on using Monte Carlo simulations to price the options. Monte Carlo methods are important in many situations where the option price admits a simple risk-neutral valuation formula but not a tractable PDE formulation, like Asian option, for example.
As a consequence, the Greeks associate with these options do not admit close form formula but can be obtained numerically by a combination of finite difference method and Monte Carlo method. Let us first outline some general principle of Monte Carlo method and variance reduction techniques.
Let be random variable and let be measurable function such that with. Then we can numerically simulate independent replicas ofdenoted byand approximate by the Monte Carlo estimator: By the law of large asian option monte carlo, we know that is a good estimate of asian option monte carlo the sense that However, it is important to understand that Monte Carlo method is never exact.
The estimating error can be quantified by the so-called standard error defined by If the standard deviation is small, then it is a good sign that with high probability our Monte Carlo result would be close to the true value.
Otherwise, the high standard deviation indicates that our result might be deviating from the true value. It is also important to observe that the standard deviation follows square root rule, which suggests that the convergence is relatively slow.
As a consequence, if the standard deviation is high, obtaining a asian option monte carlo accuracy would require high computational cost. Next, we briefly introduce some classical variance reduction techniques. The main idea is to use the same random number sequence when the target is the difference of two random variables which depends on the underlying random number sequence.
For simplicity, suppose now that we want to estimatewhere and are two random variables. It is obvious to see that If and are positively asian option monte carlo, then we could reduce the variance of the estimator.
Now suppose andwhere is a standard normal asian option monte carlo vector and and have the same monotonicity. Then the CRN estimator is defined by the following: It is easily seen that the variance of is less than the crude Monte Carlo estimator. Now let us briefly introduce the general idea of control variate method. We want to estimate. Now if we can find another random variable with known mean asian option monte carlo, then we can construct a family of unbiased estimators of: Indeed, Moreover, we have To minimize the variance ofwe could choose As a consequence, to construct a good estimator, we need to choose a random variable that is positively correlated to.
Usually, if we could find a random variable with known mean that is positively correlated towe could simply choose. Intuitively, we could think of as an error adjustment to the unadjusted estimator.
If the standard error is high, then deviation of from is large. At the same time, is large, by the fact that and are positively correlated.
It would reduce the standard error ofeven with a moderate size of. The payoff of Asian geometric option is given by Under the classical Black-Scholes model, we know that the underlying asset is a geometric Brownian motion given by see Bjork [ 12 ] asian option monte carlo more details. Let be the price of Asian geometric call option under Black-Scholes model. It is important to note that the average price follows log normal distribution. Indeed, we have Observe that the integral is normal with mean 0 and variance To simplify our notation, we denote.
By the argument above, we know that. Now by the risk-neutral valuation formula, we have On the one hand, we have where we used the fact that follows standard normal distribution and On the other hand, we got By change of variable we have Now putting all pieces together, we have Now we are ready to compute. By asian option monte carlo rule, we have. In this part, we describe the numerical scheme of the computation of Asian arithmetic option Greeks with control variate method.
Let us first remind the reader of the model. Under the risk-neutral probability measure, the dynamics of the underlying asset is described by the following stochastic differential equation: The solution is given by the geometric Brownian motion The payoff of Asian arithmetic option is given by Then the numerical scheme follows the next several steps.
Step 1 sample path generation. Let us first fix some parameters: We denoteand then we generate sample paths and by the following iterative steps: It is important to observe that we used the same random numbers for both paths andfor the purpose of variance reduction. Step 2 approximating the payoff functions of both Asian arithmetic and Asian geometric option.
We first use the Riemann sum to numerically approximate the integral. Indeed, Next, we simulate copies of asian option monte carlo Asian arithmetic option payoff Similarly, we simulate copies of the Asian geometric option payoff. Step 3 finite difference approximation. Let be the Asian asian option monte carlo option price under the Black-Scholes model, and then Similarly, we construct the sample estimator for Asian geometric option price.
Step 4 define the control sample estimator for Asian geometric option Greeks. Consider Next, let us take a look at the results of our proposed numerical simulation and compare it with the classic Common Random Number CRN for short with Table 1. It is very clear that our proposed method is better than the CRN method in the sense that it introduce much smaller standard error than the classic CRN method asian option monte carlo the same other parameters.
We study the numerical solution for the Delta of Asian arithmetic option, which was known to have no asian option monte carlo analytical closed form solution. With the Delta of Asian geometric option as a control, we provided a simple, fast, intuitive, and reliable numerical solution in the sense that the standard errors of Monte Carlo simulation were reduced greatly.
We also mention that, in recent years, many authors have been actively involved in the research of calculating Greeks of Asian type option using various approaches. For instance, in [ 13 ], the authors provided formulas for the Greeks of Asian arithmetic option, which involves the time integral of geometric Brownian asian option monte carlo. As stated in the paper, the results are consistent with the Monte Carlo simulation.
In [ 14 ], with the advanced tool of Malliavin calculus, the authors give a quasiexplicit formula for the Asian option Greeks. Also, in [ 15 ], a PDE approach was utilized to understand the numerical value of the Asian option Greeks.
To summarize, we believe that it is challenging but worth efforts to obtain more accurate value for the Asian arithmetic option Greeks, for the purpose of hedging strategy. Among various asian option monte carlo methods, our numerical scheme provides a very neat and efficient choice when one wants to calculate hedge position of a portfolio that involves the Asian average options.
Because the assumption of high correlation for the two variates needs to hold, the performance on other Greeks, however, still needs to be examined. The authors declare that there is no asian option monte carlo of interests regarding the publication of this paper. Home Journals About Us. The Scientific World Journal. Subscribe to Table of Contents Alerts.
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