Approximating payoffs and pricing formulas

Serge Darolles () and Jean-Paul Laurent ()
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Serge Darolles: DRM-Finance - DRM - Dauphine Recherches en Management - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique
Jean-Paul Laurent: Financial models, Group ALM - BNP Paribas, LSAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon

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Abstract: We use the ideas developed by Madan and Milne (1994. Mathematical Finance 3, 223-245), Lacoste (1996. Mathematical Finance 6, 197-213) to explore the optimality of polynomial approximations in pricing securities. In particular, we look at the approximations for security payoffs as well as the associated pricing formula in a L2 framework. We apply these ideas to two examples, one where the state variable follows an Ornstein-Uhlenbeck process and one based on Brownian motion with reflecting barriers, to illustrate the strengths and weaknesses of the approach.

Keywords: Infinitesimal generator; Markov process; Spectral analysis; Payoff approximation; Pricing formula (search for similar items in EconPapers)
Date: 2000-06-01
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Citations: View citations in EconPapers (6)

Published in Journal of Economic Dynamics and Control, 2000, 24 (11-12), pp.1721-1746. ⟨10.1016/S0165-1889(99)00092-5⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:halshs-00678228

DOI: 10.1016/S0165-1889(99)00092-5

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