Chuang- Chang

Efficient and accurate quadratic approximation methods for pricing Asian strike options

This study is on valuing Asian strike options and presents efficient and accurate quadratic approximation methods that work extremely well, both with regard to the volatility of a wide range of underlying assets, and longer average time windows. We demonstrate that most of the well-known quadratic approximation methods used in the literature for pricing Asian strike options are special cases of our model, with the numerical results demonstrating that our method significantly outperforms the other quadratic approximation methods examined here. Using our method for the calculation of hundreds of Asian strike options, the pricing errors (in terms of the root mean square errors) are reasonably small. Compared with the Monte Carlo benchmark method, our method is shown to be rapid and accurate. We further extend our method to the valuing of quanto forward-starting Asian strike options, with the pricing accuracy of these options being largely the same as the pricing of plain vanilla Asian strike options.

Pricing options with American-style average reset features

This study extends the Hull and White (1993 J. Derivatives 1 21-31) binomial method to construct a trinomial model for the valuation of American-style options whose strike price can be reset to a new level. The reset criterion is conditioned upon the average underlying asset price hitting the reset barrier in a specified period although the model proposed can accommodate other features. For prices benchmarked against ordinary Asian options, we investigate the difference between a daily reset warrant and a period-average reset warrant and find that the number of time steps between observations affects the value of American-style average price options and period-average reset options.

Sophistication, Sentiment, and Misreaction

This study investigates whether the existence or strength of any misreaction in the options market is affected by investor sophistication and investor sentiment. Based on a unique data set of the complete history of all transactions in the Taiwan options market, we find that individual investors exhibit significant misreaction to information and that this misreaction becomes stronger during periods of high investor sentiment. In addition, more active or aggressive individual investors always exhibit misreaction and do not learn from their past mistakes. Our empirical results are robust to alternative measures of investor sentiment and definitions of long- and short-term horizons.

A Real Option Approach to the Comprehensive Analysis of Bank Consolidation Values

This study applies a modification of the Schwartz and Moon (Financial Analysts Journal 56:62–75, 2000) model to the evaluation of bank consolidation. From our examination of a bank merger case study (the first example of such a bank merger in Taiwan), we find that, from an ex-ante viewpoint, the consolidation value is, on average, about 30% of the original total value of the independent banks. We also find that the probability of bankruptcy was considerably lower following the merger than it would have been prior to the merger. Our case study therefore indicates that the merger was indeed a worthwhile venture for both banks involved. Furthermore, on completion of the merger, we are also able to determine that, in terms of the magnitude of the increased consolidation value, the most crucial roles are played by the resultant changes in the growth rates of the integrated loans and integrated deposits, as well as the cost-saving factors within the cost functions.

Pricing Asian-Style Interest Rate Swaps

Derivatives with “Asian”-style payoffs are increasingly common, but often challenging to value. An Asian-style swap involves the exchange of interest computed at the average value of a floating rate over the period between settlement dates against a fixed swap rate. In this article, Chang and Chung derive a closed-form valuation equation for Asian swaps under the extended Vasicek interest rate model. In comparing Asian against European swap values, they show that the shape of the initial term structure makes a big difference.

Efficient procedures for the valuation and hedging of American currency options with stochastic interest rates

Abstract We develop a discrete time model to value currency options in which domestic interest rate risk, foreign interest rate risk, and currency risk are important. This model extends the Geske-Johnson (Geske, R., Johnson, 1984. ‘The American put valued analytically’, J. Finance, 39, December, 1511–1542) approach to a stochastic interest rate economy. We implement our method using only the values of once and twice exercisable options and report the results of the stochastic interest rate effects on the option values. Hence, our method provides an efficient procedure to value currency options with stochastic interest rates. In particular, it can be used to compute the values of the currency option with long-term maturity to a high degree of accuracy. Further, we also develop a simple forward hedging strategy, which can be implemented to hedge the risk from writing both the European and American currency options with stochastic interest rates. From the simulation results, we show that the interest rate risks have significant effects on the values of American currency options with long-term maturity. We also show that the hedging performance of our forward hedging strategy is significantly better than the other hedging strategy without hedging interest rate risks.

Pricing and Hedging Quanto Forward-Starting Floating-Strike Asian Options

The rapid development and proliferation of derivatives around the world has produced numerous complicated contracts. Relatively few have attracted much interest in the marketplace, but some have become actively traded. If a derivatives contract is based on an underlying asset denominated in a different currency, a quanto adjustment is required to adjust for the correlation between the exchange rate and the price of the underlying asset. If a contract is intended to hedge against an adverse price change on something that has to be purchased regularly rather than at a single future date, such as natural gas for home heating, it makes sense for its payoff to be based on the average price over a period of time. And if that averaging period starts at a future date, not at contract initiation, one can arrive at a quanto forward-starting floating- strike Asian option. This article presents approximate closed form valuation models for four different types of these contracts and provides formulas for their Greek risk exposures.

The valuation of a Euro-Convertible Bond

A Euro-Convertible Bond (ECB) is a hybrid security with the properties of both stock and bond. Further, since there are two currencies involved in this hybrid security, in addition to the conversion option, there is also a currency option embedded. We employed Least Square Monte Carlo simulation (LSM) approach developed by Longstaff and Schwartz (2001) to value ECB. The value of conversion option and currency option embedded in ECB were extracted from the differences between values of pure corporate bond, convertible bond (CB), and ECB. We also investigate the effects of exchange rate volatility, stock price volatility and correlations of state variables to the value of ECB.

Loss Aversion in Real Estate Transactions

This research examines loss aversion within the real estate market by evaluating evidence and a priori arguments on the effects of investor sentiment on willingness-to-accept among homeowners. Based upon a unique data set providing the complete histories of transactions in the real estate market, our findings reveal that the loss aversion phenomenon prevails regardless of homeowners’ gender. Interestingly, young investors, and non-owner occupied investors faced with lower-priced cases exhibit higher levels of loss aversion. By sketching the whole conditional distribution via quantile regression, this study provides new evidence suggesting difference on cognitive biases across investors’ residential region, gender, and age. Key words: Loss aversion, investor experience, quantile regression, real estate markets

Detecting and modelling the jump risk of CO2 emission allowances and their impact on the valuation of option on futures contracts

Modelling CO2 emission allowance prices is important for pricing CO2 emission allowance linked assets in the emissions trading scheme (ETS). Some statistical properties of CO2 emission allowance prices have been discovered in the literature ignoring price jumps. By employing real data from the ETS, this research first detects the jump risk using a jump test and then verifies jump effects in modelling CO2 emission allowance prices by comparing the in-sample and out-of-sample model performance. We suggest a model which can capture the statistical properties of autocorrelation, volatility clustering and jump effects is more appropriate for modelling CO2 emission allowance prices. We establish a general framework for pricing CO2 emission allowance options on futures contracts with these properties and find that the jump risk significantly affects the value of the CO2 emission allowance option on futures contracts. More importantly, we demonstrate that the dynamic jump ARMA–GARCH model can provide more accurate valuations of the CO2 emission allowance options on futures than other models in terms of pricing error.