Fractional Diffusion Models of Option Prices in Markets with Jumps
AbstractMost of the recent literature dealing with the modeling of financial assets assumes that the underlying dynamics of equity prices follow a jump process or a Levy process. This is done to incorporate rare or extreme events not captured by Gaussian models. Of those financial models proposed, the most interesting include the CGMY, KoBoL and FMLS. All of these capture some of the most important characteristics of the dynamics of stock prices. In this article we show that for these particular Levy processes, the prices of financial derivatives, such as European-style options, satisfy a fractional partial differential equation (FPDE). As an application, we use numerical techniques to price exotic options, in particular barrier options, by solving the corresponding FPDEs derived.
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Bibliographic InfoPaper provided by Birkbeck, Department of Economics, Mathematics & Statistics in its series Birkbeck Working Papers in Economics and Finance with number 0604.
Date of creation: Apr 2006
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Other versions of this item:
- Cartea, Álvaro & del-Castillo-Negrete, Diego, 2007. "Fractional diffusion models of option prices in markets with jumps," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 374(2), pages 749-763.
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.:
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