Efficient Pricing of Derivatives on Assets with Discrete Dividends

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Efficient Pricing of Derivatives on Assets with Discrete Dividends

Author Info

M. H. Vellekoop
J. W. Nieuwenhuis

Abstract

It is argued that due to inconsistencies in existing methods to approximate the prices of equity options on assets which pay out fixed cash dividends at future dates, a new approach to this problem may be useful. Logically consistent methods which are guaranteed to exclude arbitrage exist, but they are not very popular in practice due to their computational complexity. An algorithm is defined which is easy to understand, computationally efficient, and which guarantees to generate prices which exclude arbitrage possibilitites. It is shown that for the method to work a mild uniform convergence condition must be satisfied and this condition is indeed satisfied for standard European and American options. Numerical results testify to the accuracy and flexibility of the method.

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Article provided by Taylor and Francis Journals in its journal Applied Mathematical Finance.

Volume (Year): 13 (2006)
Issue (Month): 3 (September)
Pages: 265-284
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Handle: RePEc:taf:apmtfi:v:13:y:2006:i:3:p:265-284

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring. [Downloadable!] (restricted)
Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June. [Downloadable!] (restricted)

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

Marcellino Gaudenzi & Antonino Zanette, 2009. "Pricing American barrier options with discrete dividends by binomial trees," Decisions in Economics and Finance, Springer, vol. 32(2), pages 129-148, November. [Downloadable!] (restricted)
Martina Nardon & Paolo Pianca, 2008. "An efficient binomial approach to the pricing of options on stocks with cash dividends," Working Papers 178, Department of Applied Mathematics, University of Venice. [Downloadable!]

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This page was last updated on 2009-12-10.

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