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American options: the EPV pricing model

  • Svetlana Boyarchenko

    (The University of Texas at Austin)

  • Sergei Levendorskii

    (The University of Texas at Austin)

We explicitly solve the pricing problem for perpetual American puts and calls, and provide an efficient semi-explicit pricing procedure for options with finite time horizon. Contrary to the standard approach, which uses the price process as a primitive, we model the price process as the expected present value of a stream, which is a monotone function of a Levy process. Certain processes exhibiting mean-reverting, stochastic volatility and/or switching features can be modelled in this way. This specification allows us to consider assets that pay no dividends at all when the level of the underlying stochastic factor is too low, assets that pay dividends at a fixed rate when the underlying stochastic process remains in some range, or capped dividends.

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File URL: http://econwpa.repec.org/eps/fin/papers/0405/0405024.pdf
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Paper provided by EconWPA in its series Finance with number 0405024.

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Length: 19 pages
Date of creation: 18 May 2004
Date of revision:
Handle: RePEc:wpa:wuwpfi:0405024
Note: Type of Document - pdf; pages: 19
Contact details of provider: Web page: http://econwpa.repec.org

References listed on IDEAS
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  1. Ole E. Barndorff-Nielsen, 1997. "Processes of normal inverse Gaussian type," Finance and Stochastics, Springer, vol. 2(1), pages 41-68.
  2. Chernov, Mikhail & Ronald Gallant, A. & Ghysels, Eric & Tauchen, George, 2003. "Alternative models for stock price dynamics," Journal of Econometrics, Elsevier, vol. 116(1-2), pages 225-257.
  3. Svetlana Boyarchenko & Sergei Levendorskii, 2004. "Practical guide to real options in discrete time," Finance 0405016, EconWPA.
  4. Bianca Hilberink & L.C.G. Rogers, 2002. "Optimal capital structure and endogenous default," Finance and Stochastics, Springer, vol. 6(2), pages 237-263.
  5. Hans U. Gerber & Hlias S. W. Shiu, 1996. "Martingale Approach To Pricing Perpetual American Options On Two Stocks," Mathematical Finance, Wiley Blackwell, vol. 6(3), pages 303-322.
  6. Peter Carr & Helyette Geman, 2002. "The Fine Structure of Asset Returns: An Empirical Investigation," The Journal of Business, University of Chicago Press, vol. 75(2), pages 305-332, April.
  7. Svetlana Boyarchenko, 2004. "Irreversible Decisions and Record-Setting News Principles," American Economic Review, American Economic Association, vol. 94(3), pages 557-568, June.
  8. Bates, David S., 2003. "Empirical option pricing: a retrospection," Journal of Econometrics, Elsevier, vol. 116(1-2), pages 387-404.
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