Journal of Computational Finance

Pricing the correlation skew with normal mean–variance mixture copulas

Ignacio Luján Fernández

  • We propose a new pricing methodology for European multi-asset derivatives based on the family of normal mean-variance mixture copula
  • It consists of a copula-based method with the flexibility to reproduce the correlation skew, and at the same time efficient enough to be used for large baskets.
  • The model is simple, intuitive and easy to implement.
  • We exhibit its performance under several market problems where the correlation skew is involved in different ways.

In this paper we propose a new pricing methodology for European-style multi-asset derivatives based on a family of normal mean–variance mixture copulas. The goal is to develop a copula-based method that is flexible enough to reproduce correlation skew and efficient enough to be used for large baskets. Simplicity and ease of implementation are also desirable properties. After presenting the relevant pricing formulas, the methodology is then applied to several market problems where there are different forms of correlation skew.

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