The Pricing of Path-Dependent Structured Financial
Retail Products: The Case of Bonus Certificates

Abstract

For no clear reason, many retail investors seem to have an unnatural taste for exotic structured products with payoffs that depend on complex and hard-to-value contingencies. Examples include barrier reverse convertibles, turbo certificates, and the object of this article, the bonus certificate. The payoff on a bonus certificate is tied to the level at expiration of an underlying variable, such as a stock index, and the path it has followed over its lifetime. At maturity, the return is the terminal value of the underlying, plus a bonus equal to the greater of a fixed exercise price less the terminal price, which is paid only if the underlying has not penetrated a prespecified barrier level during the contract’s lifetime. Valuing such a pathdependent instrument depends heavily on the nature of the return process. Baule and Tallau investigate the pricing and performance of bonus certificates in the German market, under several alternative models, with different assumptions about volatility behavior. The general conclusion, in rough terms, is that the issuers make an excess return while the buyers pay too much.