Patent ID: 7440916

Claim:
A processor-implemented method for pricing a basket option based on N underlying component instruments, where N is an integer greater than one, the method comprising the steps of: (a) providing a volatility surface model from memory, the volatility surface model defining a volatility surface using a plurality of surface parameters β 0 . . . β n , where n is an integer greater than or equal to zero; (b) providing values for surface parameters β 0,k . . . β n,k 1≦k≦N that define, for each particular component instrument k, a respective volatility surface via the surface model for options on that component instrument; (c) determining using a processor values for surface parameters β B,0 . . . β B,n defining a volatility surface for the basket option using the surface parameters β 0,k . . . β n,k associated with each component instrument; (d) extracting using a processor a volatility value from the volatility surface for the basket option defined by surface parameters β B,0 . . . β B,n ; and (e) determining using a processor a price of the basket option based on the extracted volatility value and at least one option pricing model stored in memory.