Lie Algebraic Approach for Pricing Moving Barrier Options with Time-Dependent Parameters
Journal of Mathematical Analysis and Applications, Vol. 323, No. 2, pp. 1455-1464, 2006
10 Pages Posted: 27 Jul 2007
In this paper we apply the Lie-algebraic technique for the valuation of moving barrier options with time-dependent parameters. The value of the underlying asset is assumed to follow the constant elasticity of variance (CEV) process. By exploiting the dynamical symmetry of the pricing partial differential equations, the new approach enables us to derive the analytical kernels of the pricing formulae straightforwardly, and thus provides an efficient way for computing the prices of the moving barrier options. The method is also able to provide tight upper and lower bounds for the exact prices of CEV barrier options with fixed barriers.
In view of the CEV model being empirically considered to be a better candidate in equity option pricing than the traditional Black-Scholes model, our new approach could facilitate more efficient comparative pricing and precise risk management in equity derivatives with barriers by incorporating term-structures of interest rates, volatility and dividend into the CEV option valuation model.
Keywords: Options, Constant elasticity of variance, Partial differential equation, Lie algebra
JEL Classification: G13
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