A moment expansion approach to option pricing

Author: Airoldi Marco  

Publisher: Routledge Ltd

ISSN: 1469-7688

Source: Quantitative Finance, Vol.5, Iss.1, 2005-02, pp. : 89-104

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Abstract

In this paper we present a new methodology for option pricing. The main idea consists of representing a generic probability distribution function (PDF) by an expansion around a given, simpler, PDF (typically a Gaussian function) by matching moments of increasing order. Because, as shown in the literature, the pricing of path-dependent European options can often be reduced to recursive (or nested) one-dimensional integral calculations, the moment expansion (ME) approach leads very quickly to excellent numerical solutions. In this paper, we present the basic ideas of the method and the relative applications to a variety of contracts, mainly: Asian, reverse cliquet and barrier options. A comparison with other numerical techniques is also presented.