Technical Note No.

27*
Options, Futures, and Other Derivatives
John Hull

Calculation of Moments for Valuing Asian Options

We consider the problem of calculating the first two moments of the arithmetic average
price of an asset in a risk-neutral world when the average is calculated from discrete
observations. Suppose that the asset price is observed at times Ti (1 ≤ i ≤ m). We define
variables as follows:
Si : The value of the asset at time Ti
Fi : The forward price of the asset for a contract maturing at time Ti
σi : The implied volatility for an option on the asset with maturity Ti
ρij : Correlation between return on asset up to time Ti and the return on the asset up to
time Tj
P : Value of the arithmetic average
M1 : First moment of P in a risk-neutral world
M2 : Second moment of P in a risk-neutral world
With these definitions
m
1 X
M1 = Fi
m i=1

Also
m m
2 1 XX
P = 2 Si Sj
m i=1 j=1

In this case √
Ê(Si Sj ) = Fi Fj eρij σi σj Ti Tj

It can be shown that when i ≤ j √

σi Ti
ρij = p
σj Tj
so that 2
Ê(Si Sj ) = Fi Fj eσi Ti
and  
m m Xj−1
1 X 2 X 2
M2 = 2  Fi2 eσi Ti + 2 Fi Fj eσi Ti 
m i=1 j=1 i=1

* Copyright
c John Hull. All Rights Reserved. This note may be reproduced for use in
conjunction with Options, Futures, and Other Derivatives by John C. Hull.