Novel importance sampling for the valuation of basket and Asian options

Dagpunar, John (2007) Novel importance sampling for the valuation of basket and Asian options. SSRN Electronic Journal.

Abstract

In this paper we discuss the use of a new method of importance
sampling in the pricing of European options on a basket of assets and on
average price (Asian) options. In standard Monte Carlo estimation the ex-
pectation is taken with respect to a vector which is distributed as n variate
normal, where n is the number of assets in the basket, or the number of points
in the averaging computation in the case of an Asian option. A change of
measure which results in sampling the ratio of arithmetic to geometric average
payo¤s is central to the importance sampling method employed. Since this ra-
tio varies little, considerable variance reduction can be achieved, particularly
when the call option is ’in the money’. Experimental results are given.

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