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The GARCH Option Pricing Model: A Modification of Lattice Approach

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  • Chun-Chou Wu

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    Abstract

    Ritchken and Trevor (1999) proposed a lattice approach for pricing American options under discrete time-varying volatility GARCH frameworks. Even though the lattice approach worked well for the pricing of the GARCH options, it was inappropriate when the option price was computed on the lattice using standard backward recursive procedures, even if the concepts of Cakici and Topyan (2000) were incorporated. This paper shows how to correct the deficiency and that with our adjustment, the lattice method performs properly for option pricing under the GARCH process. Copyright Springer Science + Business Media, Inc. 2006

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    File URL: http://hdl.handle.net/10.1007/s11156-006-7033-2
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    Bibliographic Info

    Article provided by Springer in its journal Review of Quantitative Finance and Accounting.

    Volume (Year): 26 (2006)
    Issue (Month): 1 (February)
    Pages: 55-66

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    Handle: RePEc:kap:rqfnac:v:26:y:2006:i:1:p:55-66

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    Web page: http://springerlink.metapress.com/link.asp?id=102990

    Related research

    Keywords: Garch; American options; lattice algorithm; trinomial trees.;

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    1. Peter Ritchken & Rob Trevor, 1999. "Pricing Options under Generalized GARCH and Stochastic Volatility Processes," Journal of Finance, American Finance Association, vol. 54(1), pages 377-402, 02.
    2. Duan, Jin-Chuan & Simonato, Jean-Guy, 2001. "American option pricing under GARCH by a Markov chain approximation," Journal of Economic Dynamics and Control, Elsevier, vol. 25(11), pages 1689-1718, November.
    3. Jin-Chuan Duan & Evan Dudley & Geneviève Gauthier & Jean-Guy Simonato, 1999. "Pricing Discretely Monitored Barrier Options by a Markov Chain," CIRANO Working Papers 99s-15, CIRANO.
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    Cited by:
    1. In Kim & In-Seok Baek & Jaesun Noh & Sol Kim, 2007. "The role of stochastic volatility and return jumps: reproducing volatility and higher moments in the KOSPI 200 returns dynamics," Review of Quantitative Finance and Accounting, Springer, vol. 29(1), pages 69-110, July.

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