An Extension of the Chaos Expansion Approximation for the Pricing of Exotic Basket Options

Abstract

Funahashi and Kijima (in press, A chaos expansion approach for the pricing of contingent claims, Journal of Computational Finance) have proposed an approximation method based on the Wiener–Ito chaos expansion for the pricing of European-style contingent claims. In this paper, we extend the method to the multi-asset case with general local volatility structure for the pricing of exotic basket options such as Asian basket options. Through ample numerical experiments, we show that the accuracy of our approximation remains quite high even for a complex basket option with long maturity and high volatility.