An Approximation of European Option Prices under General Diffusion Processes
AbstractThis study proposes an approximation of European option prices under arbitrary diffusion processes of the spot price. The key is to approximate the characteristic function of the log spot price process as the solution to ordinary differential equations. The option price is then obtained by the inverse Fourier transform. Numerical experiments, using a model that has the constant elasticity of volatility specification in both the spot price and volatility processes, confirm reasonable accuracy of the approximation, except when the volatility process exhibits high variation.
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Bibliographic InfoPaper provided by Economics, Graduate School of Humanities and Social Sciences, University of Tsukuba in its series Tsukuba Economics Working Papers with number 2009-008.
Date of creation: Apr 2009
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-09-26 (All new papers)
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