Valuation of American Continuous-Installment Options
AbstractWe present three approaches to value American continuous-installment options written on assets without dividends or with continuous dividend yield. In an American continuous-installment option, the premium is paid continuously instead of up-front. At or before maturity, the holder may terminate payments by either exercising the option or stopping the option contract. Under the usual assumptions, we are able to construct an instantaneous riskless dynamic hedging portfolio and derive an inhomogeneous Black–Scholes partial differential equation for the initial value of this option. This key result allows us to derive valuation formulas for American continuous-installment options using the integral representation method and consequently to obtain closed-form formulas by approximating the optimal stopping and exercise boundaries as multipiece exponential functions. This process is compared to the finite difference method to solve the inhomogeneous Black–Scholes PDE and a Monte Carlo approach. Copyright Springer Science + Business Media, Inc. 2005
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Bibliographic InfoArticle provided by Society for Computational Economics in its journal Computational Economics.
Volume (Year): 25 (2005)
Issue (Month): 1 (February)
installment option; free boundary-value problem; integral representation method;
Other versions of this item:
- Pierangelo Ciurlia & Ilir Roko, 2004. "Valuation of American Continuous-Installment Options," Computing in Economics and Finance 2004 345, Society for Computational Economics.
- C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
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- S. D. Jacka, 1991. "Optimal Stopping and the American Put," Mathematical Finance, Wiley Blackwell, vol. 1(2), pages 1-14.
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