The British Asian option

Publication Type:
Journal Article
Sequential Analysis, 2010, 29 (3), pp. 311 - 327
Issue Date:
Full metadata record
Following the economic rationale of Peskir and Samee (2008a,b), we present a new class of Asian options where the holder enjoys the early exercise feature of American options whereupon his payoff (deliverable immediately) is the 'best prediction' of the European payoff under the hypothesis that the true drift of the stock price equals a contract drift. Inherent in this is a protection feature that is key to the British Asian option. Should the option holder believe the true drift of the stock price to be unfavorable (based upon the observed price movements), he can substitute the true drift with the contract drift and minimize his losses. The practical implications of this protection feature are most remarkable, as not only is the option holder afforded a unique protection against unfavorable stock price movements (covering the ability to sell in a liquid option market completely endogenously), but also when the stock price movements are favorable he will generally receive high returns. We derive a closed form expression for the arbitrage-free price in terms of the rational exercise boundary and show that the rational exercise boundary itself can be characterized as the unique solution to a nonlinear integral equation. Using these results we perform a financial analysis of the British Asian option that leads to the conclusions above and shows that with the contract drift properly selected the British Asian option becomes a very attractive alternative to the classic (European) Asian option. © Taylor & Francis Group, LLC.
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