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VolQuant
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Posts: 8
Joined: February 23rd, 2004, 2:32 pm

pde for basket option

April 26th, 2004, 7:55 am

HiCan someone tell me if we can price options on baskets (such us a call option on 3 or 4 underlyings) with the black sholes pde..In this case, which volatility will we use?? Is the pde the same as it it is for mono underlying options??Any suggestions of articles or websites will be welcome..Thank you very much
 
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DrEvil
Posts: 36
Joined: April 22nd, 2004, 10:17 pm

pde for basket option

April 26th, 2004, 1:18 pm

I don't know why you wrote this in the careers forum, but put simply, your system of SDEs for the 3-4 underlyings can be written with a decomposition of the covariance matrix of those assets, which takes into account all the volatilities and correlations between the assets. Once you've written the SDEs like this, applying Ito's lemma and deriving the pricing equation is trivial, and setting up your solution and boundary conditions becomes interesting.
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