Posted: 1 Jun 2001
Several authors have published analytical formulas for barrier options. Unfortunately, the specifications of the options studied do not match those of the options typically traded in the OTC market. One major difference concerns the frequency with which the reference index is monitored. Where academics simply assume that the index is monitored continuously, practitioners necessarily have to specify a discrete monitoring frequency. Intuitively, it is clear that discrete monitoring should cause knock-out options to become more and knock-in options to become less expensive. In this article we develop a binomial pricing procedure for the pricing of discrete barrier options, with full as well as partial monitoring. Comparisons with Monte Carlo prices show the method to be very accurate, while requiring only a fraction of the time.
JEL Classification: G13
Suggested Citation: Suggested Citation