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Closed-Form Approximation of Timer Option Prices under General Stochastic Volatility Models

Author

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  • Li, Minqiang
  • Mercurio, Fabio

Abstract

We develop an asymptotic expansion technique for pricing timer options under general stochastic volatility models around small volatility of variance. Closed-form approximation formulas have been obtained for the Heston model and the 3/2-model. The approximation has an easy-to-understand Black-Scholes-like form and many other attractive properties. Numerical analysis shows that the approximation formulas are very fast and accurate.

Suggested Citation

  • Li, Minqiang & Mercurio, Fabio, 2013. "Closed-Form Approximation of Timer Option Prices under General Stochastic Volatility Models," MPRA Paper 47465, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:47465
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    References listed on IDEAS

    as
    1. Li, Minqiang, 2008. "Closed-Form Approximations for Spread Option Prices and Greeks," MPRA Paper 6994, University Library of Munich, Germany.
    2. Peter Carr & Roger Lee, 2010. "Hedging variance options on continuous semimartingales," Finance and Stochastics, Springer, vol. 14(2), pages 179-207, April.
    3. Minqiang Li & Jieyun Zhou & Shi-Jie Deng, 2010. "Multi-asset spread option pricing and hedging," Quantitative Finance, Taylor & Francis Journals, vol. 10(3), pages 305-324.
    4. Alexander Lipton, 2001. "Mathematical Methods for Foreign Exchange:A Financial Engineer's Approach," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 4694, February.
    5. Yacine Ait-Sahalia, 2002. "Maximum Likelihood Estimation of Discretely Sampled Diffusions: A Closed-form Approximation Approach," Econometrica, Econometric Society, vol. 70(1), pages 223-262, January.
    6. Yacine Aït-Sahalia, 2001. "Transition Densities For Interest Rate And Other Nonlinear Diffusions," World Scientific Book Chapters, in: Marco Avellaneda (ed.), Quantitative Analysis In Financial Markets Collected Papers of the New York University Mathematical Finance Seminar(Volume II), chapter 1, pages 1-34, World Scientific Publishing Co. Pte. Ltd..
    7. Heston, Steven L, 1993. "A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options," The Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 327-343.
    8. Leif Andersen & Vladimir Piterbarg, 2007. "Moment explosions in stochastic volatility models," Finance and Stochastics, Springer, vol. 11(1), pages 29-50, January.
    9. Alan L. Lewis, 2000. "Option Valuation under Stochastic Volatility," Option Valuation under Stochastic Volatility, Finance Press, number ovsv, December.
    10. Ling Zhi Liang & Damiaan Lemmens & Jacques Tempere, 2011. "Path integral approach to the pricing of timer options with the Duru-Kleinert time transformation," Papers 1101.3713, arXiv.org.
    11. Avi Bick, 1995. "Quadratic-Variation-Based Dynamic Strategies," Management Science, INFORMS, vol. 41(4), pages 722-732, April.
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    Cited by:

    1. Ma, Jingtang & Deng, Dongya & Lai, Yongzeng, 2015. "Explicit approximate analytic formulas for timer option pricing with stochastic interest rates," The North American Journal of Economics and Finance, Elsevier, vol. 34(C), pages 1-21.

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    More about this item

    Keywords

    Timer Option; Closed-Form Approximation; Perturbation;
    All these keywords.

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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    This paper has been announced in the following NEP Reports:

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