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| Author: | Davydov, D. Linetsky, V. |
| Title: | Pricing and Hedging Path-Dependent Options Under the CEV Process |
| Journal: | Management Science
2001 : JUL, VOL. 47:7, p. 949-965 |
| Index terms: | DIFFUSION PRICING HEDGING |
| Language: | eng |
| Abstract: | This paper uses a more general assumption for the asset price process that provides a better fit to the empirical observations. The authors use the so-called constant elasticity of variance (CEV) diffusion model where the volatility is a function of the underlying asset price. The authors derive analytical formulae for the prices of important types of path-dependent options under this assumption. The authors demonstrate that the prices of options, which depend on extrema, such as barrier and look back options, can be much more sensitive to the specification of the underlying price process than standard call and put options and show that a financial institution that uses the standard geometric Brownian motion assumption is exposed to significant pricing and hedging errors when dealing in path-depend options. |
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