Skew-Brownian motion and pricing European exchange options

Puneet Pasricha and Xin-Jiang He

International Review of Financial Analysis, 2022, vol. 82, issue C

Abstract: This article derives a closed-form pricing formula for European exchange options under a non-Gaussian framework for the underlying assets, intending to resolve mispricing associated with a geometric Brownian motion. The dynamics of each of the two correlated underlying assets are assumed to be governed by the exponential of a skew-Brownian motion, which is specified as a sum of a standard Brownian motion and an independent reflected Brownian motion. The proposed pricing formula does not incur additional computational costs than the standard Black–Scholes framework, which one can quickly recover as a particular case of the proposed framework. Finally, we present some numerical experiments followed by a valuable discussion on the results.

Keywords: European exchange options; Skew-Brownian motion; Radon–Nikodym derivative; Non-Gaussian distribution; Owen’s T function (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:82:y:2022:i:c:s1057521922000886

DOI: 10.1016/j.irfa.2022.102120

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