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A generalization of option pricing to price-limit markets

Author

Listed:
  • Jia-Hau Guo

    (National Chiao Tung University)

  • Lung-Fu Chang

    (National Taipei University of Business)

Abstract

This paper proposes an analytic solution for pricing options in markets with daily price limits. The Black–Scholes model is a nested case in which the daily price limit approaches infinity. Compared to the Black–Scholes model, our solution may solve the mispricing problem and could yield consistent results with existing numerical methods. Practitioners trading options in price-limit markets may resort to the finite difference method or Monte Carlo simulations. However, applying these numerical methods is often time consuming, thereby further illustrating the importance of an analytic solution.

Suggested Citation

  • Jia-Hau Guo & Lung-Fu Chang, 2020. "A generalization of option pricing to price-limit markets," Review of Derivatives Research, Springer, vol. 23(2), pages 145-161, July.
    • Handle: RePEc:kap:revdev:v:23:y:2020:i:2:d:10.1007_s11147-019-09160-1
    DOI: 10.1007/s11147-019-09160-1
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    References listed on IDEAS

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    More about this item

    Keywords

    Daily price limit; Analytic solution; Local times; Backward equation; Characteristic function; Fast Fourier transform;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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