On the qualitative effect of volatility and duration on prices of Asian options

Peter Carr, Christian Oliver Ewald, Yajun Xiao

Research output: Contribution to journalArticlepeer-review

Abstract

We show that under the Black-Scholes assumption the price of an arithmetic average Asian call option with fixed strike increases with the level of volatility. This statement is not trivial to prove and for other models in general wrong. In fact we demonstrate that in a simple binomial model no such relationship holds. Under the Black-Scholes assumption however, we give a proof based on the maximum principle for parabolic partial differential equations. Furthermore we show that an increase in the length of duration over which the average is sampled also increases the price of an arithmetic average Asian call option, if the discounting effect is taken out. To show this, we use the result on volatility and the fact that a reparametrization in time corresponds to a change in volatility in the Black-Scholes model. Both results are extremely important for the risk management and risk assessment of portfolios that include Asian options.

Original languageEnglish (US)
Pages (from-to)162-171
Number of pages10
JournalFinance Research Letters
Volume5
Issue number3
DOIs
StatePublished - Sep 2008

Keywords

  • Asian options
  • Duration
  • Qualitative risk-management
  • Vega
  • Volatility

ASJC Scopus subject areas

  • Finance

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