A Numerical Analysis of the Modified Kirk's Formula and Applications to Spread Option Pricing Approximations a numerical analysis of the modified kirk's formula and applications to spread option pricing approximations

TL;DR

This paper evaluates a modified version of Kirk's formula for spread option pricing, demonstrating its superior accuracy over the original, especially in high-correlation scenarios, through extensive simulation testing.

Contribution

The paper introduces a modified Kirk's approximation method that significantly improves accuracy in spread option pricing, particularly under high correlation conditions.

Findings

Modified Kirk's method outperforms original in accuracy.

Extensive simulations validate the improved approximation.

High correlation scenarios are better handled by the new method.

Abstract

In this paper we study recent developments in the approximation of the spread option pricing. As the Kirk\'s Approximation is extremely flawed in the cases when the correlation is very high, we explore a recent development that allows approximating with simplicity and accuracy the option price. To assess the goodness of fit of the new method, we increase dramatically the number of simulations and scenarios to test the new method and compare it with the original Kirk\'s formula. The simulations confirmed that the Modified Kirk\'s Approximation method is extremely accurate, improving Kirk\'s approach for two-asset spread options.