Title: Two-Color Partial Rainbow Options
Reference Number: 1104
Publication Date: January 2004

Der-Chen Chang, Haitao Fan, Duy-Minh Nhieu
Georgetown University

Eric Chang
The University of Hong Kong

Two-color partial rainbow options, or TCPRO for short, are proposed. Such options allow holders to choose between the two underlying vanilla options at a specifed 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 coeffcient of the two underlying assets and the remaining time to choosing. 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.

Published in Applicable Analysis 84:7 (2005), pp. 737-757.

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Last modified: 01/24/2007