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I'm trying to determine the value of a call option with the following vesting feature:the option vests only if its returns over a 5 year period are at or above the median return of a peer group consisting of 7 pre-identified companies.My thoughts were to model the vesting based on Monte Carlo simulation where I would determine the 5 year returns for each of the companies based on their volatility; however, I suspect there's a strong correlation in the returns of the 8 companies (7 in the peer group + my company). What is the best way for me to account for correlation?How would I determine expected correlation (would this be the correlation of my company to an index comprised of the 7 peer group companies? Would I need to run correlations of each of the 8 companies to the others and take some average?)?Thanks in advance!

what is a "peer" group? does every parameter have to match to be a peer?

The peer group is already determined. They are a collection of competitors and companies exposed to similar macroeconomic factors.

QuoteOriginally posted by: tttchenWhat is the best way for me to account for correlation?QuoteI would simulate a joint lognormal distribution for the 8 companies. This means drawing 8 correlated normal variables at each time step.Search the forum for 'cholesky' for how to do this.regards,

Thanks! Sorry, I should have searched the forums first...didn't know this was such a common question.