Pricing Virtual Paths with Quality-of-Service Guarantees as Bundle Derivatives

TL;DR

This paper models the pricing of complex network services with QoS guarantees as financial derivatives, providing a theoretical framework and hedging strategies for such pricing in communication networks.

Contribution

It introduces a Girsanov transform theorem for pricing linear derivatives on network capacity, enabling valuation of complex virtual channel options.

Findings

Provides a pricing model for virtual channel options.

Derives a risk-neutral continuous-time hedging strategy.

Offers a numerical method for evaluating the option price density.

Abstract

We describe a model of a communication network that allows us to price complex network services as financial derivative contracts based on the spot price of the capacity in individual routers. We prove a theorem of a Girsanov transform that is useful for pricing linear derivatives on underlying assets, which can be used to price many complex network services, and it is used to price an option that gives access to one of several virtual channels between two network nodes, during a specified future time interval. We give the continuous time hedging strategy, for which the option price is independent of the service providers attitude towards risk. The option price contains the density function of a sum of lognormal variables, which has to be evaluated numerically.