Perpetual American vanilla option pricing under single regime change risk: an exhaustive study

DOI10.1088/1742-5468/2009/07/P07016MaRDI QIDQ3301076zbMATH OpenOpenAlexFDO

Authors Miquel Montero

Publication date 11 August 2020

Published in Journal of Statistical Mechanics: Theory and Experiment (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/0812.0556

zbMATH Keywords

stochastic processesfinancial instruments and regulationmodels of financial marketsrisk measure and management

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20)

Abstract: Perpetual American options are financial instruments that can be readily exercised and do not mature. In this paper we study in detail the problem of pricing this kind of derivatives, for the most popular flavour, within a framework in which some of the properties |volatility and dividend policy| of the underlying stock can change at a random instant of time, but in such a way that we can forecast their final values. Under this assumption we can model actual market conditions because most relevant facts usually entail sharp predictable consequences. The effect of this potential risk on perpetual American vanilla options is remarkable: the very equation that will determine the fair price depends on the solution to be found. Sound results are found under the optics both of finance and physics. In particular, a parallelism among the overall outcome of this problem and a phase transition is established.

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• Volatility and dividend risk in perpetual American options

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