A closer look at barrier exchange options

Christine Ann Brown, John C Handley, Ken Palmer

    Research output: Contribution to journalArticleResearchpeer-review

    Abstract

    A barrier exchange option is an exchange option that is knocked out the first time the prices of two underlying assets become equal. Lindset, S., Persson, S.-A. (2006) present a simple dynamic replication argument to show that, in the absence of arbitrage, the current value of the barrier exchange option is equal to the difference in the current prices of the underlying assets and that this pricing formula applies irrespective of whether the option is European or American. In this study, we take a closer look at barrier exchange options and show, despite the simplicity of the pricing formula presented by Lindset, S., Persson, S.-A. (2006), that the barrier exchange option in fact involves a surprising array of key concepts associated with the pricing of derivative securities including: put-call parity, barrier in-out parity, static vs. dynamic replication, martingale pricing, continuous vs. discontinuous price processes, and numeraires. We provide valuable intuition behind the pricing formula which explains its apparent simplicity.
    Original languageEnglish
    Pages (from-to)29 - 43
    Number of pages15
    JournalJournal of Futures Markets
    Volume33
    Issue number1
    DOIs
    Publication statusPublished - 2013

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