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Perpetual American options in a diffusion model with piecewise-linear coefficients

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  • Gapeev Pavel V.
  • Rodosthenous Neofytos

Abstract

We derive closed form solutions to the discounted optimal stopping problems related to the pricing of the perpetual American standard put and call options in an extension of the Black–Merton–Scholes model with piecewise-constant dividend and volatility rates. The method of proof is based on the reduction of the initial optimal stopping problems to the associated free-boundary problems and the subsequent martingale verification using a local time-space formula. We present explicit algorithms to determine the constant hitting thresholds for the underlying asset price process, which provide the optimal exercise boundaries for the options.

Suggested Citation

  • Gapeev Pavel V. & Rodosthenous Neofytos, 2013. "Perpetual American options in a diffusion model with piecewise-linear coefficients," Statistics & Risk Modeling, De Gruyter, vol. 30(1), pages 1-21, March.
    • Handle: RePEc:bpj:strimo:v:30:y:2013:i:1:p:1-21:n:4
    DOI: 10.1524/strm.2013.1135
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    References listed on IDEAS

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    6. Aurélien Alfonsi & Benjamin Jourdain, 2008. "General Duality For Perpetual American Options," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 11(06), pages 545-566.
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