World Library  
Flag as Inappropriate
Email this Article

Rainbow option

Article Id: WHEBN0012235870
Reproduction Date:

Title: Rainbow option  
Author: World Heritage Encyclopedia
Language: English
Subject: Correlation swap, Options (finance), Model risk, Diagonal spread, Cliquet
Publisher: World Heritage Encyclopedia

Rainbow option

Rainbow option is a derivative exposed to two or more sources of uncertainty,[1] as opposed to a simple option that is exposed to one source of uncertainty, such as the price of underlying asset. Rainbow options are usually calls or puts on the best or worst of n underlying assets, or options which pay the best or worst of n assets.[2] The number of assets underlying the option is called the number of colours of the rainbow.[3] The options are often considered a correlation trade since the value of the option is sensitive to the correlation between the various basket components.

Rainbow options are used, for example, to value natural resources deposits. Such assets are exposed to two uncertainties—price and quantity.

Some simple options can be transformed into more complex instruments if the underlying risk model that the option reflected does not match a future reality. In particular, derivatives in the currency and mortgage markets have been subject to liquidity risk that was not reflected in the pricing of the option when sold.

Pricing and Valuation

Rainbow options are usually priced using an appropriate industry-standard model (such as Black–Scholes) for each individual basket component, and a matrix of correlation coefficients applied to the underlying stochastic drivers for the various models. While degenerate cases have simpler solutions, the general case must be approached with Monte Carlo methods.


  1. ^ "What Does Rainbow Option Mean?".  
  2. ^ "Supported Equity Derivatives". Retrieved 2014-02-12. 
  3. ^ Rainbow options

External links

  • Rainbow Options at
  • Rainbow options Mark Rubinstein
  • Rainbow option calculator

This article was sourced from Creative Commons Attribution-ShareAlike License; additional terms may apply. World Heritage Encyclopedia content is assembled from numerous content providers, Open Access Publishing, and in compliance with The Fair Access to Science and Technology Research Act (FASTR), Wikimedia Foundation, Inc., Public Library of Science, The Encyclopedia of Life, Open Book Publishers (OBP), PubMed, U.S. National Library of Medicine, National Center for Biotechnology Information, U.S. National Library of Medicine, National Institutes of Health (NIH), U.S. Department of Health & Human Services, and, which sources content from all federal, state, local, tribal, and territorial government publication portals (.gov, .mil, .edu). Funding for and content contributors is made possible from the U.S. Congress, E-Government Act of 2002.
Crowd sourced content that is contributed to World Heritage Encyclopedia is peer reviewed and edited by our editorial staff to ensure quality scholarly research articles.
By using this site, you agree to the Terms of Use and Privacy Policy. World Heritage Encyclopedia™ is a registered trademark of the World Public Library Association, a non-profit organization.

Copyright © World Library Foundation. All rights reserved. eBooks from World eBook Library are sponsored by the World Library Foundation,
a 501c(4) Member's Support Non-Profit Organization, and is NOT affiliated with any governmental agency or department.