CONSTANT ELASTICITY OF VARIANCE OPTION PRICING MODEL WITH TIME-DEPENDENT PARAMETERS

C. F. Lo (), P. H. Yuen and C. H. Hui ()
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C. F. Lo: Dept. of Physics, The Chinese University of Hong Kong, Shatin, New Territories, Hong Kong, China
P. H. Yuen: Dept. of Physics, The Chinese University of Hong Kong, Shatin, New Territories, Hong Kong, China
C. H. Hui: Banking Policy Dept., Hong Kong Monetary Authority, Hong Kong, China

International Journal of Theoretical and Applied Finance (IJTAF), 2000, vol. 03, issue 04, 661-674

Abstract: This paper provides a method for pricing options in the constant elasticity of variance (CEV) model environment using the Lie-algebraic technique when the model parameters are time-dependent. Analytical solutions for the option values incorporating time-dependent model parameters are obtained in various CEV processes with different elasticity factors. The numerical results indicate that option values are sensitive to volatility term structures. It is also possible to generate further results using various functional forms for interest rate and dividend term structures. Furthermore, the Lie-algebraic approach is very simple and can be easily extended to other option pricing models with well-defined algebraic structures.

Keywords: Options; constant elasticity of variance; partial differential equation; Lie algebra (search for similar items in EconPapers)
Date: 2000
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Citations: View citations in EconPapers (21)

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DOI: 10.1142/S0219024900000814

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