Perpetual American options with asset-dependent discounting

DOI10.1007/S00245-023-10084-4MaRDI QIDQ6139952zbMATH OpenOpenAlexFDO

Authors Jonas Al-Hadad, Zbigniew Palmowski

Publication date 19 January 2024

Published in Applied Mathematics and Optimization (Search for Journal in Brave)

Copyright license Creative Commons Attribution 4.0 International

Full work available at URL https://arxiv.org/abs/2007.09419

zbMATH Keywords

diffusionAmerican optionconvexityoptimal stopping problemBlack-Scholes marketLévy process

Mathematics Subject Classification ID

Processes with independent increments; Lévy processes (60G51) Derivative securities (option pricing, hedging, etc.) (91G20) Stopping times; optimal stopping problems; gambling theory (60G40)

Abstract: In this paper we consider the following optimal stopping problem ${\displaystyle }$V^{omega}_{ m A}(s) = sup_{ auinmathcal{T}} mathbb{E}_{s}[e^{-int_0^ au omega(S_w) dw} g(S_ au)],${\displaystyle }$ where the process $S_t$ is a jump-diffusion process, $mathcalT$ is a family of stopping times while $g$ and $omega$ are fixed payoff function and discount function, respectively. In a financial market context, if $g(s)=(K-s{)}^{+}$ or $g(s)=(s-K{)}^{+}$ and $mathbbE$ is the expectation taken with respect to a martingale measure, $V_{mA}^{omega}(s)$ describes the price of a perpetual American option with a discount rate depending on the value of the asset process $S_t$. If $omega$ is a constant, the above problem produces the standard case of pricing perpetual American options. In the first part of this paper we find sufficient conditions for the convexity of the value function $V_{mA}^{omega}(s)$. This allows us to determine the stopping region as a certain interval and hence we are able to identify the form of $V_{mA}^{omega}(s)$. We also prove a put-call symmetry for American options with asset-dependent discounting. In the case when $S_t$ is a geometric L'evy process we give exact expressions using the so-called omega scale functions introduced in Li and Palmowski (2018). We prove that the analysed value function satisfies the HJB equation and we give sufficient conditions for the smooth fit property as well. Finally, we present a few examples for which we obtain the analytical form of the value function $V_{mA}^{omega}(s)$.

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