Pricing of Spreads and Other Options in Cointegrated Markets

Abstract

In this thesis we analyze spread functions in the cointegrated market, with dynamics based on different combinations of Brownian motions and Ornstein-Uhlenbeck processes, and their structural differences. Theoretical and computational methods for pricing these options are explored, and we will discuss the parameters and dynamics of the price functions by examining analytical expressions and numerical simulations. The extention of cointegrated spreads to quanto options is also touched upon. We use the mean-reversal, stationary dynamic of Ornstein-Uhlenbeck spreads to suggest a model on the form of an European put-option to approximate quanto options in cointegrated markets, which are based on a product of spreads.