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Valuation of forward start options under affine jump-diffusion models

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  • João Pedro Vidal Nunes
  • Tiago Ramalho Viegas Alcaria

Abstract

Under the general affine jump-diffusion framework of Duffie et al. [ Econometrica , 2000, 68 , 1343--1376], this paper proposes an alternative pricing methodology for European-style forward start options that does not require any parallel optimization routine to ensure square integrability. Therefore, the proposed methodology is shown to possess a better accuracy--efficiency trade-off than the usual and more general approach initiated by Hong [Forward Smile and Derivative Pricing. Working paper, UBS, 2004] that is based on the knowledge of the forward characteristic function . Explicit pricing solutions are also offered under the nested jump-diffusion setting proposed by Bakshi et al. [ J. Finance , 1997, 52 , 2003--2049], which accommodates stochastic volatility and stochastic interest rates, and different integration schemes are numerically tested.

Suggested Citation

  • João Pedro Vidal Nunes & Tiago Ramalho Viegas Alcaria, 2016. "Valuation of forward start options under affine jump-diffusion models," Quantitative Finance, Taylor & Francis Journals, vol. 16(5), pages 727-747, May.
    • Handle: RePEc:taf:quantf:v:16:y:2016:i:5:p:727-747
    DOI: 10.1080/14697688.2015.1049200
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    References listed on IDEAS

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    1. Fang, Fang & Oosterlee, Kees, 2008. "A Novel Pricing Method For European Options Based On Fourier-Cosine Series Expansions," MPRA Paper 9319, University Library of Munich, Germany.
    2. Bakshi, Gurdip & Cao, Charles & Chen, Zhiwu, 1997. "Empirical Performance of Alternative Option Pricing Models," Journal of Finance, American Finance Association, vol. 52(5), pages 2003-2049, December.
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    4. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 8, pages 229-288, World Scientific Publishing Co. Pte. Ltd..
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