Rainbow can take various other forms but the combining idea is to have a payoff that is depending on the assets sorted by their performance at maturity.
When the rainbow only pays the best (or worst) performing asset of the basket, it is also called best-of (or worst-of).
[5] A simple example is a call rainbow option written on FTSE 100, Nikkei and S&P 500 which will pay out the difference between the strike price and the level of the index that has risen by the largest amount of the three.
In particular, derivatives in the currency and mortgage markets have been subject to liquidity risk that was not reflected in the pricing of the option when sold.
[3] Examples of these include:[7] Thus, the payoffs at expiry for rainbow European options are: Rainbow options are usually priced using an appropriate industry-standard model (such as Black–Scholes) for each individual basket component, and a matrix of correlation coefficients applied to the underlying stochastic drivers for the various models.