An Approximation Scheme for Option Pricing Under Two-State Continuous CAPM

Ali Safdari-Vaighani (), Davood Ahmadian () and Roja Javid-Jahromi ()
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Ali Safdari-Vaighani: Allameh Tabataba’i University
Davood Ahmadian: University of Tabriz
Roja Javid-Jahromi: Shahed University

Computational Economics, 2021, vol. 57, issue 4, No 18, 1373-1385

Abstract: Abstract Option pricing under continuous-time CAPM has been formulated by partial differential equation, which is an extension of the Black–Scholes PDE. The focus of this paper is to present the radial basis function partition of unity method for evaluation of options in which underlying asset price follows the two-state continuous CAPM. Our experiments illustrate the behavior of the market volatility skew and the effect of the asset’s beta on option price. The numerical examples show that the proposed scheme is accurate and competitive with finite difference method.

Keywords: Two-state CAPM; European option; Radial basis function; Partition of unity; Implied volatility; MSC 65M70; MSC 91G80 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:kap:compec:v:57:y:2021:i:4:d:10.1007_s10614-020-10024-2

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DOI: 10.1007/s10614-020-10024-2

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