Modeling autocallable structured products

Abstract

Since first introduced in 2003, the number of autocallable structured products in the United States has increased exponentially. The autocall feature causes the product to be redeemed if the reference asset's value rises above a pre-specified call price. Because an autocallable structured product matures immediately if it is called, the autocall feature reduces the product's duration and expected maturity. In this article, we present a flexible Partial Differential Equation framework to model autocallable structured products. Our framework allows for products with either discrete or continuous call dates. We value the autocallable structured products with discrete call dates using the finite difference method, and the products with continuous call dates using a closed-form solution. In addition, we estimate the probabilities of an autocallable structured product being called on each call date. We demonstrate our models by valuing a popular autocallable product and quantify the cost to the investor of adding this feature to a structured product. © 2011 Macmillan Publishers Ltd.