High-order short-time expansions for ATM option prices under the CGMY model

Jos\'e E. Figueroa-L\'opez, Ruoting Gong and Christian Houdr\'e

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Abstract: The short-time asymptotic behavior of option prices for a variety of models with jumps has received much attention in recent years. In the present work, a novel second-order approximation for ATM option prices under the CGMY L\'evy model is derived, and then extended to a model with an additional independent Brownian component. Our results shed light on the connection between both the volatility of the continuous component and the jump parameters and the behavior of ATM option prices near expiration. In case of an additional Brownian component, the second-order term, in time-t, is of the form $ d_{2} t^{(3-Y)/2}$, with the coefficient $d_{2}$ depending only on the overall jump intensity parameter C and the tail-heaviness parameter Y. This extends the known result that the leading term is $(\sigma/\sqrt{2\pi})t^{1/2}$, where $\sigma$ is the volatility of the continuous component. In contrast, under a pure-jump CGMY model, the dependence on the two parameters C and Y is already reflected in the leading term, which is of the form $d_{1} t^{1/Y}$. Information on the relative frequency of negative and positive jumps appears only in the second-order term, which is shown to be of the form $d_{2} t$ and whose order of decay turns out to be independent of Y. The third-order asymptotic behavior of the option prices as well as the asymptotic behavior of the corresponding Black-Scholes implied volatilities are also addressed. Our numerical results show that in most cases the second-order term significantly outperform the first-order approximation.

Date: 2011-12, Revised 2012-08
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