Pricing discretely monitored barrier options under markov processes through markov chain approximation

Zhenyu Cui, Stephen Taylor

Research output: Contribution to journalArticlepeer-review

Abstract

The authors propose an explicit closed-form approximation formula for the price of discretely monitored single or double barrier options with an underlying asset that evolves according to a one-dimensional Markov process, which includes diffusion and jump-diffusion processes. The prices and Greeks of a discretely monitored double barrier option are explicitly expressed in terms of rudimentary matrix operations. In addition, this framework may be extended to include additional features of barrier options often encountered in practice—for example, time-dependent barriers and nonuniform monitoring time intervals. They provide numerical examples to demonstrate the accuracy and efficiency of the proposed formula as well as its ability to reproduce existing benchmark results in the relevant literature in a unified framework.

Original languageEnglish (US)
Pages (from-to)8-33
Number of pages26
JournalJournal of Derivatives
Volume28
Issue number3
DOIs
StatePublished - Mar 2021

All Science Journal Classification (ASJC) codes

  • Finance
  • Economics and Econometrics

Keywords

  • Derivatives
  • Options

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