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Investment / Financial Markets Old Exam MFE Forum

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Old 02-22-2018, 02:49 PM
kimmik kimmik is offline
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Default Asian Option Pricing Question

Here is a quote from the ACTEX MFE Fall 2017 Study manual(page M4-5):

"Effect of Averaging
The number of averaging n has a great impact on the prices of Asian options. For average price Asian options, the price is a decreasing function of n. For average strike Asian options, the price is an increasing function of n."

I fail to see how this makes any sense because the payoff for an avg price Asian call has a reciprocal relation to the avg price compared to a similar put.

I also fail to see how the number of sample points can always have the same effect on price when the average is highly dependent on the profile of asset price. A concave - up function will have a lower average with more sampling and a concave - down function will have a higher average with more sampling.

Any insight as to whether this paragraph makes sense or not will be greatly appreciated!
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Old 02-22-2018, 03:12 PM
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Average Price Option:

For average price option, as N increases, the average stock price, S_bar, has less volatility. This makes it less likely to have a large payoff. As a result, the value of an average price Asian option decreases as N increases.

Here's another perspective to help you remember whether the value of an average price Asian option will increase or decrease as N increases.

When N=1, the only observation in the average stock price is the final stock price, i.e., S_bar=S(T). Thus, the payoff of an average price Asian option equals the payoff of a corresponding European option.

Recall the value of an average price Asian option is always less than or equal to that of an equivalent European option. Notice when N=1, the value of an average price Asian option is already at its maximum. Thus, when N increases, the value of the average price option cannot increase any further, so it must decrease.

Average Strike Option:

​​For average strike option, as N increases, it is more likely that the average stock price, S_bar, will be further away from the final stock price, S(T). As a result, the value of an average strike Asian option increases as N increases.

Here's another perspective to help you remember whether the value of an average strike Asian option will increase or decrease as N increases.

When N=1, the only observation in the average stock price is the final stock price, i.e., S_bar=S(T). Thus, the payoffs of the average strike Asian options are equal to 0.

Recall an option owner can choose not to exercise an option if it produces a negative payoff. As a result, the value of an option cannot be negative, which means the minimum value of an option is 0. Notice when N=1, the value of the average strike Asian option is already at its minimum, i.e., 0. Thus, when N increases, the value of the average strike option cannot decrease further, and it will increase.

Hope this helps!
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