RAINBOW OPTIONS

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Options involving two or more risk assets are sometimes referred to as Rainbow Options. There are three types of Rainbow Options: "better-of", "worse-of", and "out-performance".

Assuming no arbitrage possibilities, the following parameters are needed to price a rainbow option:

  1. Tenor of the Option: T
  2. Spot price of the underlyings
  3. Dividend rates for the underlyings
  4. Volatility of the underlyings
  5. Correlation between returns of asset A and B
The pricing of a rainbow option is independent of an interest rate.

In this calculator example, we price 3 types of rainbow options which involve two underlyings (two color rainbow option). Interest rates are assumed to be semiannually compounded.

Pricing Models Page Available is a Swing Java Jar File if you just wish to run the models.


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