Scandinavian Working Papers in Business Administration
Finance Research Group Working Papers,
University of Aarhus, Aarhus School of Business, Department of Business Studies
No F-2008-01: Pricing of Traffic Light Options and other Correlation Derivatives
Thomas Kokholm ()
Additional contact information
Thomas Kokholm: Department of Business Studies, Aarhus School of Business, Postal: The Aarhus School of Business, Fuglesangs Allé 4, 8210 Aarhus V, Denmark
Abstract: This paper considers derivatives with payo¤s that depend on a stock index and underlying LIBOR rates. A tra¢ c light option pricing formula is derived un- der lognormality assumptions on the underlying processes. The tra¢ c light option is aimed at the Danish life and pension sector to help companies stay solvent in the tra¢ c light stress test system introduced by the Danish Financial Supervisory Authorities in 2001. Similar systems are now being implemented in several other European countries. A pricing approach for general payo¤s is presented and illustrated with simulation via the pricing of a hybrid derivative known as the EUR Sage Note. The approach can be used to price many existing structured products.
Keywords: LIBOR market model; traffic light option; correlation; simulation; derivatives pricing; structured products
28 pages, February 19, 2008
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F-2008-01
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