Correlation Risk in Multiasset Equity Options Pricing

Evaluating any equity opion with multiple underlying assets requires to estimate correlation coefficients among asset returns. Despite recent develpment of copula techniques, in fact, pricing is largely based on simpler techniques assuming multivariate normal returns and relying on historical correltation inputs. We show that the potential impact on estimated fair price of choices about sample size and return data frequency when estiamting historical correlations may be huge, and suggest how correlation input rosk in option pricing could be controlled through what-if analyses and an "average correlation vega" by traders, risk managers and auditors concerned with IAS39-complaint fair value estimates.

CAMPOLONGO Francesca;  JOOSSENS Elisabeth;  SAITA Francesco;  ROMANO Maria Egle; 

2007-07-24

Newfin, Università Bocconi

JRC37109

https://publications.jrc.ec.europa.eu/repository/handle/JRC37109,