Simplified Valuation of Single-Payoff Financial Instruments.

Cheung and Chung (1996) presented a set of four basic components that can be used to reconstruct piecewise linear payoff diagrams associated with single-payoff instruments. Arbitrage arguments indicate that this provides a method to value complex financial instruments as the sum of the values of their underlying basic components. We present a modified scheme using two hybrid components which were constructed so that each piecewise linear segment can be replicated independently. This leads to a simple algorithm that is amenable to quick computer implementation. Copyright 1999 by Kluwer Academic Publishers