McKean’s Method applied to American Call Options on Jump-Diffusion Processes
In this paper we derive the implicit integral equation for the price of an American call option in the case where the underlying asset follows a jump-diffusion process. We extend McKean's incomplete Fourier transform approach to solve the free boundary problem under Merton's framework, with the distribution for the jump size remaining unspecified. We show how our results are consistent with those of Gukhal (2001), who derived the same integral equation using the Geske-Johnson discretisation approach. The paper also derives some results concerning the limit for the free boundary at expiry, and presents an iterative numerical algorithm for solving the linked integral equation system for the American call's price and early exercise boundary. This scheme is applied to Merton's jump-diffusion model, where the jumps are log-normally distributed.
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|Date of creation:||01 Aug 2003|
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- Carl Chiarella & Boda Kang & Gunter H. Meyer, 2014. "Introduction," World Scientific Book Chapters, in: The Numerical Solution of the American Option Pricing Problem Finite Difference and Transform Approaches, chapter 1, pages 1-2 World Scientific Publishing Co. Pte. Ltd..
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"Evaluation of American Strangles,"
Research Paper Series
83, Quantitative Finance Research Centre, University of Technology, Sydney.
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- 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 637-54, May-June.
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