CEV Asymptotics of American Options

CEV Asymptotics of American Options

The constant elasticity of variance (CEV) model is a practical approach to option pricing by fitting to the implied volatility smile. Its application to American-style derivatives, however, poses analytical and numerical challenges. By taking the Laplace–Carson transform (LCT) to the free-boundary v...

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Bibliographic Details
Main Authors: Pun, Chi Seng, Wong, Hoi Ying
Other Authors: School of Physical and Mathematical Sciences
Format: Article
Language:English
Published: 2016
Subjects:
Perturbation technique
CEV model
American options
Partial differential equation
Online Access:https://hdl.handle.net/10356/81381
http://hdl.handle.net/10220/40732
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Institution: Nanyang Technological University
Language: English
Description
Summary:The constant elasticity of variance (CEV) model is a practical approach to option pricing by fitting to the implied volatility smile. Its application to American-style derivatives, however, poses analytical and numerical challenges. By taking the Laplace–Carson transform (LCT) to the free-boundary value problem characterizing the option value function and the early exercise boundary, the analytical result involves confluent hyper-geometric functions. Thus, the numerical computation could be unstable and inefficient for certain set of parameter values. We solve this problem by an asymptotic approach to the American option pricing problem under the CEV model. We demonstrate the use of the proposed approach using perpetual and finite-time American puts.

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