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Multinomial method for option pricing under Variance Gamma

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  • Nicola Cantarutti
  • Jo~ao Guerra

Abstract

This paper presents a multinomial method for option pricing when the underlying asset follows an exponential Variance Gamma process. The continuous time Variance Gamma process is approximated by a discrete time Markov chain with the same firsts four cumulants. This approach is particularly convenient for pricing American and Bermudan options, which can be exercised at any time up to expiration date. Numerical computations of European and American options are presented, and compared with results obtained with finite differences methods and with the Black Scholes model.

Suggested Citation

  • Nicola Cantarutti & Jo~ao Guerra, 2016. "Multinomial method for option pricing under Variance Gamma," Papers 1701.00112, arXiv.org, revised Feb 2018.
    • Handle: RePEc:arx:papers:1701.00112
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    File URL: http://arxiv.org/pdf/1701.00112
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    References listed on IDEAS

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    1. Dilip B. Madan & Peter P. Carr & Eric C. Chang, 1998. "The Variance Gamma Process and Option Pricing," Review of Finance, European Finance Association, vol. 2(1), pages 79-105.
    2. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," The Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 113-147.
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    4. Dilip B. Madan & Frank Milne, 1991. "Option Pricing With V. G. Martingale Components1," Mathematical Finance, Wiley Blackwell, vol. 1(4), pages 39-55, October.
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    6. Rama Cont & Ekaterina Voltchkova, 2005. "A Finite Difference Scheme for Option Pricing in Jump Diffusion and Exponential Lévy Models," Post-Print halshs-00445645, HAL.
    7. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    8. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    9. Dilip B. Madan & Frank Milne, 1991. "Option Pricing With V. G. Martingale Components," Working Paper 1159, Economics Department, Queen's University.
    10. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," University of California at Los Angeles, Anderson Graduate School of Management qt43n1k4jb, Anderson Graduate School of Management, UCLA.
    11. Madan, Dilip B & Seneta, Eugene, 1990. "The Variance Gamma (V.G.) Model for Share Market Returns," The Journal of Business, University of Chicago Press, vol. 63(4), pages 511-524, October.
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