Arbitrage Bounds on Currency Basket Options

Abstract

This article exploits arbitrage valuation bounds on currency basket options. Instead of using a sophisticated model to price these options, we consider a set of pricing models that are consistent with the prices of available hedging assets. In the absence of arbitrage, we identify valuation bounds on currency basket options without model specifications. Our results extend the work in the literature by seeking tight arbitrage valuation bounds on these options. Specifically, the valuation bounds are enforced by static portfolios that consist of both cross-currency options and individual options denominated in the numeraire currency.

Keywords

• currency basket options
• static hedging
• arbitrage bounds