Asian options versus vanilla options: a boundary analysis

Abstract

Purpose

The purpose of the paper is to correct a commonly mistaken notion that an Asian option is always cheaper than its plain vanilla European counterpart in a general setting.

Design/methodology/approach

The paper shows that by letting volatility go to zero, the lower bounds of Asian options and vanilla options are derived. Those bounds are then compared.

Findings

The paper finds that the notion can be violated for call options when the dividend yield of the underlying stock is higher than the interest rate, as well as for put options when the dividend yield of the underlying stock is lower than the interest rate.

Research limitations/implications

The approach used in this paper, boundary analysis, can be applied to other exotic options.

Practical implications

The results in the paper may affect decisions on trading Asian options.

Originality/value

The paper will be of value to those interested in using/pricing/hedging Asian options.

Citation

Ye, G.L. (2008), "Asian options versus vanilla options: a boundary analysis", Journal of Risk Finance, Vol. 9 No. 2, pp. 188-199. https://doi.org/10.1108/15265940810853931