Perpetual American Vanilla Option Pricing Under Single Regime Change Risk - An Exhaustive Study

Posted: 2 Dec 2008

See all articles by Miquel Montero

Miquel Montero

University of Barcelona - Departament de Física de la Matèria Condensada

Date Written: December 2, 2008

Abstract

Perpetual American options are financial instruments that can be readily exercised and do not mature. In this paper we study in detail the problem of pricing this kind of derivatives, for the most popular flavour, within a framework in which some of the properties volatility and dividend policy of the underlying 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 most relevant facts usually entail sharp predictable consequences. The effect of this potential risk on perpetual American vanilla options is remarkable: the very equation that will determine the fair price depends on the solution to be found. Sound results are found under the optics both of finance and physics. In particular, a parallelism among the overall outcome of this problem and a phase transition is established.

Suggested Citation

Montero, Miquel, Perpetual American Vanilla Option Pricing Under Single Regime Change Risk - An Exhaustive Study (December 2, 2008). Available at SSRN: https://ssrn.com/abstract=1310342

Miquel Montero (Contact Author)

University of Barcelona - Departament de Física de la Matèria Condensada ( email )

Martí i Franquès, 1
Barcelona, Catalonia 08028
Spain
+34 93 403 92 53 (Phone)
+34 93 402 11 55 (Fax)

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