Representation of Exchange Option Prices under Stochastic Volatility Jump-Diffusion Dynamics

Gerald H. L. Cheang and Len Patrick Dominic M. Garces

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Abstract: In this article, we provide representations of European and American exchange option prices under stochastic volatility jump-diffusion (SVJD) dynamics following models by Merton (1976), Heston (1993), and Bates (1996). A Radon-Nikodym derivative process is also introduced to facilitate the shift from the objective market measure to other equivalent probability measures, including the equivalent martingale measure. Under the equivalent martingale measure, we derive the integro-partial differential equation that characterizes the exchange option prices. We also derive representations of the European exchange option price using the change-of-numeraire technique proposed by Geman et al. (1995) and the Fourier inversion formula derived by Caldana and Fusai (2013), and show that these two representations are comparable. Lastly, we show that the American exchange option price can be decomposed into the price of the European exchange option and an early exercise premium.

Date: 2020-02
New Economics Papers: this item is included in nep-ore
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Published in Quantitative Finance 20(2), 291-310

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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:2002.10202

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