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http://ssrn.com/abstract=943045
 
 

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Volatility and Dividend Risk in Perpetual American Options


Miquel Montero


University of Barcelona - Department de Física Fonamental

March 5, 2007


Abstract:     
American options are financial instruments that can be exercised at any time before expiration. In this paper we study the problem of pricing this kind of derivatives within a framework in which some of the properties - volatility and dividend policy - of the underlaying stock can change at a random instant of time, but in such a way that we can forecast their final values. Under this assumption we can model actual market conditions because some of the most relevant facts that may potentially affect a firm will entail sharp predictable effects. We will analyse the consequences of this potential risk on perpetual American derivatives, a topic connected with a wide class of recurrent problems in physics: holders of American options must look for the fair price and the optimal exercise strategy at once, a typical question of free absorbing boundaries. We present explicit solutions to the most common contract specifications and derive analytical expressions concerning the mean and higher moments of the exercise time.

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Date posted: November 9, 2006  

Suggested Citation

Montero, Miquel, Volatility and Dividend Risk in Perpetual American Options (March 5, 2007). Available at SSRN: http://ssrn.com/abstract=943045 or http://dx.doi.org/10.2139/ssrn.943045

Contact Information

Miquel Montero (Contact Author)
University of Barcelona - Department de Física Fonamental ( email )
Diagonal 647
Barcelona, Catalonia 08028
Spain
+34 93 403 92 07 (Phone)
+34 93 402 11 49 (Fax)
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