A Simple Closed-Form Approximation for Constant Elasticity of Variance Spread Options

19 Pages Posted: 15 Aug 2013

See all articles by Chi-Fai Lo

Chi-Fai Lo

The Chinese University of Hong Kong

Xiao Fen Zheng

The Chinese University of Hong Kong

Date Written: August 15, 2013

Abstract

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

Lo, Chi-Fai and Zheng, Xiao Fen, A Simple Closed-Form Approximation for Constant Elasticity of Variance Spread Options (August 15, 2013). Available at SSRN: https://ssrn.com/abstract=2310503 or http://dx.doi.org/10.2139/ssrn.2310503

Chi-Fai Lo (Contact Author)

The Chinese University of Hong Kong ( email )

Department of Physics
Shatin, N.T., Hong Kong
China

Xiao Fen Zheng

The Chinese University of Hong Kong ( email )

Shatin, N.T.
Hong Kong
China

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