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Pricing American options under the constant elasticity of variance model: An extension of the method by Barone-Adesi and Whaley

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  • Ballestra, Luca Vincenzo
  • Cecere, Liliana

Abstract

We consider the problem of pricing American options on an underlying described by the constant elasticity of variance (CEV) model. Such a problem does not have an exact closed-form solution, and therefore some kind of approximation is required. In this paper we extend the approach proposed by Barone-Adesi and Whaley (1997), which allows us to obtain a direct semi-analytical approximate solution. Numerical experiments are presented showing that the proposed method is satisfactorily accurate and computationally very fast.

Suggested Citation

  • Ballestra, Luca Vincenzo & Cecere, Liliana, 2015. "Pricing American options under the constant elasticity of variance model: An extension of the method by Barone-Adesi and Whaley," Finance Research Letters, Elsevier, vol. 14(C), pages 45-55.
    • Handle: RePEc:eee:finlet:v:14:y:2015:i:c:p:45-55
    DOI: 10.1016/j.frl.2015.05.017
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    1. Hsu, Y.L. & Lin, T.I. & Lee, C.F., 2008. "Constant elasticity of variance (CEV) option pricing model: Integration and detailed derivation," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 79(1), pages 60-71.
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    Cited by:

    1. Jia‐Hau Guo & Lung‐Fu Chang, 2020. "Repeated Richardson extrapolation and static hedging of barrier options under the CEV model," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(6), pages 974-988, June.
    2. Shi, Guangping & Liu, Xiaoxing & Tang, Pan, 2016. "Pricing options under the non-affine stochastic volatility models: An extension of the high-order compact numerical scheme," Finance Research Letters, Elsevier, vol. 16(C), pages 220-229.
    3. Aricson Cruz & José Carlos Dias, 2020. "Valuing American-style options under the CEV model: an integral representation based method," Review of Derivatives Research, Springer, vol. 23(1), pages 63-83, April.
    4. Oleg L. Kritski & Vladimir F. Zalmezh, 2017. "Asymptotics for Greeks under the constant elasticity of variance model," Papers 1707.04149, arXiv.org, revised Jul 2017.
    5. Liu, Yanchu & Cui, Zhenyu & Zhang, Ning, 2016. "Integral representation of vega for American put options," Finance Research Letters, Elsevier, vol. 19(C), pages 204-208.
    6. Chinonso Nwankwo & Weizhong Dai & Tony Ware, 2023. "Enhancing accuracy for solving American CEV model with high-order compact scheme and adaptive time stepping," Papers 2309.03984, arXiv.org, revised Sep 2023.

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    More about this item

    Keywords

    CEV model; American option; Barone-Adesi and Whaley; Free boundary; Option pricing;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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