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edit approved Feb 14, 2019 at 12:10
luchonacho
edit approved Feb 14, 2019 at 12:10
luchonacho
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I read from various sources (eg. Exotic Options and Hybrids, M. Bouzoubaa) that the correlation sensitivity of Rainbow options (say a call price on a basket made of 50% of the best stock, 20% of the worst, 30% of the 3rd one) is uncertain due to 2 opposite effects:

  • Increasing correlation would increase the overall basket volatility, thus tends to push the option price higher

  • Increasing correlation would decrease the Forward price, thus tends to push the option price lower

I do not understand the reason for the 2nd point - how come an increase in correlation decreases the Forward price?

Many thanks in advance for your help

I read from various sources (eg. Exotic Options and Hybrids, M. Bouzoubaa) that the correlation sensitivity of Rainbow options (say a call price on a basket made of 50% of the best stock, 20% of the worst, 30% of the 3rd one) is uncertain due to 2 opposite effects:

  • Increasing correlation would increase the overall basket volatility, thus tends to push the option price higher

  • Increasing correlation would decrease the Forward price, thus tends to push the option price lower

I do not understand the reason for the 2nd point - how come an increase in correlation decreases the Forward price?

Many thanks in advance for your help

I read from various sources (eg. Exotic Options and Hybrids, M. Bouzoubaa) that the correlation sensitivity of Rainbow options (say a call price on a basket made of 50% of the best stock, 20% of the worst, 30% of the 3rd one) is uncertain due to 2 opposite effects:

  • Increasing correlation would increase the overall basket volatility, thus tends to push the option price higher

  • Increasing correlation would decrease the Forward price, thus tends to push the option price lower

I do not understand the reason for the 2nd point - how come an increase in correlation decreases the Forward price?

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Alex
Alex
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Correlation sensitivity of Rainbow options

I read from various sources (eg. Exotic Options and Hybrids, M. Bouzoubaa) that the correlation sensitivity of Rainbow options (say a call price on a basket made of 50% of the best stock, 20% of the worst, 30% of the 3rd one) is uncertain due to 2 opposite effects:

  • Increasing correlation would increase the overall basket volatility, thus tends to push the option price higher

  • Increasing correlation would decrease the Forward price, thus tends to push the option price lower

I do not understand the reason for the 2nd point - how come an increase in correlation decreases the Forward price?

Many thanks in advance for your help