Asian options versus vanilla options: a boundary analysis

Abstract

PurposeThe 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/approachThe 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.FindingsThe 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/implicationsThe approach used in this paper, boundary analysis, can be applied to other exotic options.Practical implicationsThe results in the paper may affect decisions on trading Asian options.Originality/valueThe paper will be of value to those interested in using/pricing/hedging Asian options.