  How to price and hedge claims on nontraded assets are becoming increasingly
important matters in option pricing theory today. The most common practice to
deal with these issues is to use another similar or "closely related" asset or
index which is traded, for hedging purposes. Implicitly, traders assume here
that the higher the correlation between the traded and nontraded assets, the
better the hedge is expected to perform. This raises the question as to how
\textquoteleft{}closely related\textquoteright{} the assets really are. In this
paper, the concept of twin assets is introduced, focusing the discussion
precisely in what does it mean for two assets to be similar. Our findings point
to the fact that, in order to have very similar assets, for example identical
twins, high correlation measures are not enough. Specifically, two basic
criteria of similarity are pointed out: i) the coefficient of variation of the
assets and ii) the correlation between assets. From here, a method to measure
the level of similarity between assets is proposed, and secondly, an option
pricing model of twin assets is developed. The proposed model allows us to
price an option of one nontraded asset using its twin asset, but this time
knowing explicitly what levels of errors we are facing. Finally, some numerical
illustrations show how twin assets behave depending upon their levels of
similarities, and how their potential differences will traduce in MAPE (mean
absolute percentage error) for the proposed option pricing model.
