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Option Pricing with Lie Symmetry Analysis and Similarity Reduction Method


  • Wenqing Bao
  • ChunLi Chen
  • Jin E. Zhang


With some transformations, we convert the problem of option pricing under state-dependent volatility into an initial value problem of the Fokker-Planck equation with a certain potential. By using the Lie symmetry analysis and similarity reduction method, we are able to reduce the dimensions of the partial differential equation and find some of its particular solutions of the equation. A few case studies demonstrate that our new method can be used to produce analytical option pricing formulas for certain volatility functions.

Suggested Citation

  • Wenqing Bao & ChunLi Chen & Jin E. Zhang, 2013. "Option Pricing with Lie Symmetry Analysis and Similarity Reduction Method," Papers 1311.4074,
  • Handle: RePEc:arx:papers:1311.4074

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    References listed on IDEAS

    1. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters,in: Theory Of Valuation, chapter 8, pages 229-288 World Scientific Publishing Co. Pte. Ltd..
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    3. Schroder, Mark Douglas, 1989. " Computing the Constant Elasticity of Variance Option Pricing Formula," Journal of Finance, American Finance Association, vol. 44(1), pages 211-219, March.
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    6. C. F. Lo & C. H. Hui, 2001. "Valuation of financial derivatives with time-dependent parameters: Lie-algebraic approach," Quantitative Finance, Taylor & Francis Journals, vol. 1(1), pages 73-78.
    7. Jin Zhang & Yi Xiang, 2008. "The implied volatility smirk," Quantitative Finance, Taylor & Francis Journals, vol. 8(3), pages 263-284.
    8. Jin E. Zhang & Yishen Li, 2012. "New analytical option pricing models with Weyl--Titchmarsh theory," Quantitative Finance, Taylor & Francis Journals, vol. 12(7), pages 1003-1010, June.
    9. Vadim Linetsky, 2004. "Spectral Expansions for Asian (Average Price) Options," Operations Research, INFORMS, vol. 52(6), pages 856-867, December.
    10. 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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