BARRIER OPTION PRICING BY BRANCHING PROCESSES

Georgi K. Mitov (), Svetlozar T. Rachev (), Young Shin Kim () and Frank Fabozzi ()
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Georgi K. Mitov: Institute of Mathematics and Informatics, Bulgarian Academy of Science, "Acad. G. Bonchev" Str., Bl. 8, 1113, Sofia Bulgaria;
Svetlozar T. Rachev: School of Economics and Business Engineering, University of Karlsruhe and KIT, Kollegium am Schloss, Bau II, 20.12, R210, Postfach 6980, D-76128, Karlsruhe, Germany;
Young Shin Kim: Department of Statistics, Econometrics and Mathematical Finance, School of Economics and Business Engineering, University of Karlsruhe, Germany;

International Journal of Theoretical and Applied Finance (IJTAF), 2009, vol. 12, issue 07, 1055-1073

Abstract: This paper examines the pricing of barrier options when the price of the underlying asset is modeled by a branching process in a random environment (BPRE). We derive an analytical formula for the price of an up-and-out call option, one form of a barrier option. Calibration of the model parameters is performed using market prices of standard call options. Our results show that the prices of barrier options that are priced with the BPRE model deviate significantly from those modeled assuming a lognormal process, despite the fact that for standard options, the corresponding differences between the two models are relatively small.

Keywords: Barrier option; up-and-out call option; Bienayme-Galton-Watson branching process; branching process in a random environment (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (1)

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DOI: 10.1142/S0219024909005555

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