Business Commons^™

Pricing Asian Options: Volatility Forecasting As A Source Of Downside Risk, Adam T. Diehl

Undergraduate Economic Review

Asian options are a class of derivative securities whose payoffs average movements in the underlying asset as a means of hedging exposure to unexpected market behavior. We find that despite their volatility smoothing properties, the price of an Asian option is sensitive to the choice of volatility model employed to price them from market data. We estimate the errors induced by two common schemes of forecasting volatility and their potential impact upon trading.