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An efficient binomial approach to the pricing of options on stocks with cash dividends

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Author Info

  • Martina Nardon

    ()
    (Department of Applied Mathematics, University of Venice)

  • Paolo Pianca

    ()
    (Department of Applied Mathematics, University of Venice)

Abstract

In this contribution, we consider options written on stocks which pay cash dividends. Dividend payments have an effect on the value of options: high dividends imply lower call premia and higher put premia. While exact solutions to problems of evaluating both European and American call options and European put options are available in the literature, for American-style put options early exercise may be optimal at any time prior to expiration even in the absence of dividends. In this case numerical techniques, such as lattice approaches, are required. Discrete dividends produce a shift in the tree; as a result, the tree is no longer reconnecting beyond any dividend date. Methods based on non-recombining trees give consistent results, but they are computationally expensive. We analyze binomial algorithms and performed some empirical experiments.

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File Function: First version, 2008
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Bibliographic Info

Paper provided by Department of Applied Mathematics, Università Ca' Foscari Venezia in its series Working Papers with number 178.

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Length: 14 pages
Date of creation: Nov 2008
Date of revision:
Handle: RePEc:vnm:wpaper:178

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Keywords: Options on stocks; discrete dividends; binomial lattices;

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  1. Geske, Robert, 1979. "The valuation of compound options," Journal of Financial Economics, Elsevier, vol. 7(1), pages 63-81, March.
  2. Geske, Robert, 1981. "Comments on Whaley's note," Journal of Financial Economics, Elsevier, vol. 9(2), pages 213-215, June.
  3. Amaro de Matos, Joao & Dilao, Rui & Ferreira, Bruno, 2006. "The exact value for European options on a stock paying a discrete dividend," MPRA Paper 701, University Library of Munich, Germany.
  4. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
  5. M. H. Vellekoop & J. W. Nieuwenhuis, 2006. "Efficient Pricing of Derivatives on Assets with Discrete Dividends," Applied Mathematical Finance, Taylor & Francis Journals, vol. 13(3), pages 265-284.
  6. Antonella Basso & Martina Nardon & Paolo Pianca, 2004. "A two-step simulation procedure to analyze the exercise features of American options," Decisions in Economics and Finance, Springer, vol. 27(1), pages 35-56, 08.
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