Pricing American Options under the Constant Elasticity of Variance Model and Subject to Bankruptcy

This paper proposes an alternative characterization of the early exercise premium that is valid for any Markovian and diffusion underlying price process as well as for any parameterization of the exercise boundary. This new representation is shown to provide the best pricing alternative available in...

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Bibliographic Details
Published inJournal of financial and quantitative analysis Vol. 44; no. 5; pp. 1231 - 1263
Main Author Nunes, João Pedro Vidal
Format Journal Article
LanguageEnglish
Published New York, USA Cambridge University Press 01.10.2009
Subjects
American option
American options
Approximation
Asset pricing
Bankruptcy
Brownian motion
Differential equations
Financial engineering
Modeling
Option pricing
Polynomials
Put options
Quantitative analysis
Stock prices
Valuation
Variance
Yield
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Summary:This paper proposes an alternative characterization of the early exercise premium that is valid for any Markovian and diffusion underlying price process as well as for any parameterization of the exercise boundary. This new representation is shown to provide the best pricing alternative available in the literature for medium- and long-term American option contracts, under the constant elasticity of variance model. Moreover, the proposed pricing methodology is also extended easily to the valuation of American options on defaultable equity and possesses appropriate asymptotic properties.
Bibliography:ArticleID:99032
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PII:S0022109009990329
An earlier version of this paper was presented at the 2006 Derivatives Securities and Risk Management Conference (Arlington, VA) and at the 2006 Bachelier Finance Society Fourth World Congress (Tokyo), under the title “A General Characterization of the Early Exercise Premium.” The author thanks Hendrik Bessembinder (the editor) and Ren-Raw Chen (the referee), whose suggestions have significantly improved this article, as well as the helpful programming codes and comments provided by Nico Temme. Of course, all the remaining errors are the author’s responsibility exclusively.
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ISSN:0022-1090
1756-6916
DOI:10.1017/S0022109009990329