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Efficient Pricing of Derivatives on Assets with Discrete Dividends

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  • M. H. Vellekoop
  • J. W. Nieuwenhuis

Abstract

It is argued that due to inconsistencies in existing methods to approximate the prices of equity options on assets which pay out fixed cash dividends at future dates, a new approach to this problem may be useful. Logically consistent methods which are guaranteed to exclude arbitrage exist, but they are not very popular in practice due to their computational complexity. An algorithm is defined which is easy to understand, computationally efficient, and which guarantees to generate prices which exclude arbitrage possibilitites. It is shown that for the method to work a mild uniform convergence condition must be satisfied and this condition is indeed satisfied for standard European and American options. Numerical results testify to the accuracy and flexibility of the method.

Suggested Citation

  • 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.
  • Handle: RePEc:taf:apmtfi:v:13:y:2006:i:3:p:265-284
    DOI: 10.1080/13504860600563077
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    References listed on IDEAS

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    1. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
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    Citations

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    Cited by:

    1. Martina Nardon & Paolo Pianca, 2008. "An efficient binomial approach to the pricing of options on stocks with cash dividends," Working Papers 178, Department of Applied Mathematics, Università Ca' Foscari Venezia.
    2. Ruediger Frey & Lars Roesler & Dan Lu, 2017. "Corporate Security Prices in Structural Credit Risk Models with Incomplete Information: Extended Version," Papers 1701.04780, arXiv.org, revised May 2017.
    3. Damir Filipovi'c & Sander Willems, 2018. "A Term Structure Model for Dividends and Interest Rates," Papers 1803.02249, arXiv.org.
    4. Ma, Jingtang & Fan, Jiacheng, 2016. "Convergence rates of recombining trees for pricing options on stocks under GBM and regime-switching models with known cash dividends," The North American Journal of Economics and Finance, Elsevier, vol. 37(C), pages 128-147.
    5. Martina Nardon & Paolo Pianca, 2012. "Extracting information on implied volatilities and discrete dividends from American options prices," Working Papers 2012_25, Department of Economics, University of Venice "Ca' Foscari".
    6. Alexander Buryak & Ivan Guo, 2014. "New analytic approach to address Put - Call parity violation due to discrete dividends," Papers 1407.7328, arXiv.org.
    7. Antonio Cosma & Stefano Galluccio & Paola Pederzoli & Olivier Scaillet, 2016. "Early exercise decision in American options with dividends, stochastic volatility and jumps," Papers 1612.03031, arXiv.org.
    8. Marcellino Gaudenzi & Antonino Zanette, 2009. "Pricing American barrier options with discrete dividends by binomial trees," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 32(2), pages 129-148, November.
    9. German Bernhart & Jan-Frederik Mai, 2016. "On the impact of a scrip dividend on an equity forward," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 3(04), pages 1-16, December.
    10. Katarzyna Toporek, 2012. "Simple is better. Empirical comparison of American option valuation methods," Ekonomia journal, Faculty of Economic Sciences, University of Warsaw, vol. 29.

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