basket dispersion

omniaz · October 19th, 2005, 6:37 pm

can anybody tell me something about basket dispersion?and how can should we hedge the correlation, volatility etc...thanks

Stochastix · October 20th, 2005, 3:09 pm

Given a correlation structure for the stocks in a basket and volatility surfaces for each of them, you should be able to compute the volatlity of options on the basket. There is obviously an upper bound to the basket's volatility (Jensen's inequality). Some will make the rough approximation of putting all correlation pairs equal to a constant. By doing so, you are able to extract from a basket's volatility and the volatility of its stocks, the implied correlation. If the implied correlation is above 1, they would sell the basket option and buy individual ones.

qxiaking · October 21st, 2005, 1:10 pm

Hi, StochastixThat's the risk neutral implied correlation. We may also get the statistical implied correlation backing out from the historical component stock prices. Can we also find some trading opportunity from the difference between these two?