Research

An approximation formula for basket option prices under local stochastic volatility with jumps: an application to commodity markets (Revised version of CARF-F-336; Subsequently published in “Journal of Computational and Applied Mathematics”)

Author

Abstract

This paper develops a new approximation formula for pricing basket options in a local-stochastic volatility model with jumps. In particular, the model admits local volatility functions and jump components in not only the underlying asset price processes, but also the volatility processes. To the best of our knowledge, the proposed formula is the first one which achieves an analytical approximation for the basket option prices under this type of the models. Moreover, in numerical experiments, we provide approximate prices for basket options on the WTI futures and Brent futures based on the parameters through calibration to the plain-vanilla option prices, and confirm the validity of our approximation formula.