Scandinavian Working Papers in Economics

Knut Wicksell Working Paper Series,
Lund University, Knut Wicksell Centre for Financial Studies

No 2015/3: No 2015:3 Closed Form Valuation of Three-Asset Spread Options With a view towards Clean Dark Spreads

Rikard Green
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Rikard Green: Knut Wicksell Centre for Financial Studies, Lund University

Abstract: We perform a slight generalization of the Bjerksund and Stensland (2011) spread option valuation formula to cover three-asset spread options. We investigate the pricing performance of the model against the corresponding version of the Kirk formula and the true price calculated with Monte Carlo methods. The numerical setting of the evaluation is designed to mimic a real market situation in the German OTC market for clean dark spread options. The results show that both models give similar and accurate price estimates (compared to the true option price). Comparing the performance between the models we conclude that the three-asset Bjerksund-Stensland formula performs marginally better compared to the three-asset Kirk formula (counting the number of test cases with the lowest absolute pricing error against the true option price).

Keywords: Clean dark spreads; Energy markets; Financial derivatives; Spread options

JEL-codes: D81; G12; G13

20 pages, May 19, 2015

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