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Option prices from operational-time reaction-boundary lattices

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  • Chris Angstmann
  • Tim Gebbie

Abstract

We consider the role of a continuum operational time $u$, its mapping to calendar time $t$, and their relation to event time in option-pricing problems. We derive option-pricing equations from an operational-time Markov lattice rather than from a calendar-time diffusion. The primitive model is a homogeneous nearest-neighbour log-price lattice; state-dependent local variance is represented through its general local-kernel extension. Its Chapman--Kolmogorov decomposition yields discrete forward and backward equations. In price variables, the backward equation gives a generalized European pricing PDE and reduces to Black--Scholes--Merton under the risk-neutral drift restriction and constant volatility. Interpreted as a reaction boundary, the lattice gives a structural route from boundary variance to projected local volatility. The key point is the separation of the operational kernel, the calendar-time clock projection, and the pricing-measure choice. Within the deterministic one-factor local-volatility class, an option surface identifies the projected clock--variance combination rather than its operational variance and clock components separately. The resulting hierarchy also distinguishes full calendar-generator equivalence from weaker terminal or continuum matching, and clarifies why incompleteness concerns unspanned clock, jump, or renewal risks rather than random time alone.

Suggested Citation

  • Chris Angstmann & Tim Gebbie, 2026. "Option prices from operational-time reaction-boundary lattices," Papers 2606.09564, arXiv.org, revised Jul 2026.
  • Handle: RePEc:arx:papers:2606.09564
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    References listed on IDEAS

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    Cited by:

    1. Chris Angstmann & Tim Gebbie, 2026. "Reaction-boundary variance and adjoint-consistent local-volatility projection," Papers 2607.05011, arXiv.org, revised Jul 2026.

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