A systematic approach for valuing European-style installment options with continuous payment plan
AbstractIn this paper we present an integral equation approach for the valuation of European-style installment derivatives when the premium payments, made continuously throughout the contract’s life, are assumed to be a function of the asset price and time variables. The contribution of this study is threefold. First, we show that in the Black-Scholes framework the option pricing problem can be formulated as a free boundary problem under very general conditions on payo structure and installment payment plan. Second, by applying a Fourier transform-based solution technique, we derive a recursive integral equation for the free boundary along with a general integral representation for the option initial premium. Third, within this systematic treatment of the European installment options, we propose a unified and easily applicable method to deal with a broad range of monotonic payo functions and continuous payment plans depending on the time variable only. Finally, by using the illustrative example of European vanilla installment call options, an explicit valuation formula is obtained for the class of linear time-varying installment payment functions.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Department of Economics - University Roma Tre in its series Departmental Working Papers of Economics - University 'Roma Tre' with number 0115.
Date of creation: Apr 2010
Date of revision:
Contact details of provider:
Postal: Via Silvio d'Amico 77, - 00145 Rome Italy
Phone: +39 06 57114612
Fax: +39 06 57114771
Web page: http://host.uniroma3.it/dipartimenti/economia/it/
More information through EDIRC
Installment options; free boundary problem; Fourier transform; integral representations;
Find related papers by JEL classification:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-05-08 (All new papers)
You can help add them by filling out this form.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Telephone for information).
If references are entirely missing, you can add them using this form.