Compound contingent claims

Abstract

This paper explores similarities and differences between a compound option and a two-period guarantee. A generalised compound contingent claim that captures these two claims as special cases is constructed. The underlying asset of the compound contingent claim is a generalised simple contingent claim. Similar parities as the put-call parity are derived for both these claims. Also several other claims captured by the two general claims are revealed. We also show that the derivation of a closed form solution for the market value of a compound option under stochastic interest rates is likely to be non-trivial, if possible at all.