Pricing Barrier Options With Square Root Process

14 Pages Posted: 8 May 2007

See all articles by Chi-Fai Lo

Chi-Fai Lo

The Chinese University of Hong Kong

P. H. Yuen

affiliation not provided to SSRN

Cho-Hoi Hui

Hong Kong Monetary Authority - Research Department

Abstract

The square root constant elasticity of variance (CEV) process has been paid little attention in previous research on valuation of barrier options. In this paper we derive analytical option pricing formulae of up-and-out options with this process using the eigenfunction expansion technique. We develop an efficient algorithm to compute the eigenvalues where the basis functions in the formulae are the confluent hypergeometric functions. The numerical results obtained from the formulae are compared with the corresponding model prices under the Black-Scholes model. We find that the differences in the model prices between the square root CEV model and the Black-Scholes model can be significant as the time to maturity and volatility increases.

Keywords: Barrier options, constant elasticity of variance

JEL Classification: F31, G13

Suggested Citation

Lo, Chi-Fai and Yuen, P. H. and Hui, Cho-Hoi, Pricing Barrier Options With Square Root Process. International Journal of Theoretical and Applied Finance, Vol. 4, No. 5, pp. 805-818, 2001. Available at SSRN: https://ssrn.com/abstract=984374

Chi-Fai Lo (Contact Author)

The Chinese University of Hong Kong ( email )

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

P. H. Yuen

affiliation not provided to SSRN ( email )

No Address Available

Cho-Hoi Hui

Hong Kong Monetary Authority - Research Department ( email )

Hong Kong
China

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