A Simple Closed-Form Approximation for Constant Elasticity of Variance Spread Options
19 Pages Posted: 15 Aug 2013
Date Written: August 15, 2013
By applying the Lie-Trotter operator splitting method and the idea of the WKB method, we have developed a simple, accurate and efficient analytical approximation for pricing the constant elasticity of variance (CEV) spread options. The derived option price formula bears a striking resemblance to Kirk's formula of the Black-Scholes spread options. Illustrative numerical examples show that the proposed approximation is not only extremely fast and robust, but also it is remarkably accurate for typical volatilities and maturities of up to two years.
Keywords: Constant elasticity of variance model, Spread options, Lie-Trotter operator splitting method, WKB method, Kirk's approximation
JEL Classification: C00, G00
Suggested Citation: Suggested Citation