Option pricing with a quadratic diffusion term

Rady, Sven (1995) Option pricing with a quadratic diffusion term. Financial Markets Group Discussion Papers (226). Financial Markets Group, The London School of Economics and Political Science, London, UK.

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Abstract

Several authors have derived closed-form option prices in models where the underlying financial variable follows a diffusion process with the following two characteristics: (i) the process has natural upper and lower boundaries; (ii) its diffusion coefficient is quadratic in the current value of the variable. The present paper uses a probabilistic change-of-numeraire technique to compute the corresponding option price formula. In particular, it shows how to interpret the formula in terms of exercise probabilities which are calculated under the martingale measures associated with two specific numeraire portfolios.

Item Type:	Monograph (Discussion Paper)
Official URL:	https://www.fmg.ac.uk/
Additional Information:	© 1995 The Author(s)
Divisions:	Financial Markets Group
Subjects:	H Social Sciences > HC Economic History and Conditions H Social Sciences > HG Finance
JEL classification:	G - Financial Economics > G1 - General Financial Markets > G10 - General G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions
Date Deposited:	22 May 2023 15:24
Last Modified:	14 Sep 2024 04:35
URI:	http://eprints.lse.ac.uk/id/eprint/119174

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