The IRMA Community
Newsletters
Research IRM
Click a keyword to search titles using our InfoSci-OnDemand powered search:
|
Computational Techniques for Pricing Options
Abstract
In 1973, Fischer Black and Myron Scholes [1] made a major breakthrough by developing a model for pricing stock options. In 1997, they were awarded the Nobel Prize in Economics for their outstanding work. The Black-Scholes model and its extensions are very popular for pricing many types of options. Individuals, corporations, and many financial institutions use derivatives like options and futures to reduce risk exposures. The Black-Scholes model is based on the assumption that trading takes place continuously in time. In 1979, J. Cox, S. Ross, and M. Rubinstein [4] developed a binomial model that is based on discrete trading time. In applications such as American option valuation, the binomial model is widely used by many financial institutions. Derivatives with more complicated payoffs than the standard European or American call options and put options are sometimes referred to as exotic options. Most exotic options trade in over-the counter market and are designed by financial institutions to meet the requirements of their clients. In this paper we will discuss some computational techniques for pricing standard options and certain exotic options, American Lookback put options. The payoff from the Lookback options depend upon the maximum or minimum stock price reached during the life of the option. In 1992, S. Babbs [2] used the binomial tree approach for pricing American Lookback put options. Prof. E. Reiner proposed the same approach in a lecture at Berkeley. The tree approach has many advantages. It could be used for both European and American style options. When exact formulas are not available (e.g. American put option), numerical procedures such as Monte Carlo simulation, binomial and trinomial trees are widely used in real life. Moreover, the analytic results assume that the stock price is observed continuously. But if the stock price is observed in a discrete manner, say once a day, to calculate the maximum or the minimum, the tree approach makes more sense.
|
|