Pricing Barrier Options With Square Root Process
The Chinese University of Hong Kong
P. H. Yuen
affiliation not provided to SSRN
C. H. Hui
Hong Kong Monetary Authority - Research Department
International Journal of Theoretical and Applied Finance, Vol. 4, No. 5, pp. 805-818, 2001
The square root constant elasticity of variance (CEV) process has been paid little attention in previous research on valuation of barrier options. In this paper we derive analytical option pricing formulae of up-and-out options with this process using the eigenfunction expansion technique. We develop an efficient algorithm to compute the eigenvalues where the basis functions in the formulae are the confluent hypergeometric functions. The numerical results obtained from the formulae are compared with the corresponding model prices under the Black-Scholes model. We find that the differences in the model prices between the square root CEV model and the Black-Scholes model can be significant as the time to maturity and volatility increases.
Number of Pages in PDF File: 14
Keywords: Barrier options, constant elasticity of variance
JEL Classification: F31, G13
Date posted: May 8, 2007
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