QUANTO PRICING IN STOCHASTIC CORRELATION MODELS

Abstract

Correlation plays an important role in pricing multi-asset options. In this work we incorporate stochastic correlation into pricing quanto options which is one special and important type of multi-asset option. Motivated by the market observations that the correlations between financial quantities behave like a stochastic process, instead of using a constant correlation, we allow the asset price process and the exchange rate process to be stochastically correlated with a parameter which is driven either by an Ornstein–Uhlenbeck process or a bounded Jacobi process. We derive an exact quanto option pricing formula in the stochastic correlation model of the Ornstein–Uhlenbeck process and a highly accurate approximated pricing formula in the stochastic correlation model of the bounded Jacobi process, where correlation risk has been hedged. The comparison between prices using our pricing formula and the Monte-Carlo method are provided.