Partial differential equations for Asian option prices

Christine Ann Brown, John Handley, C.-T. Lin, Ken Palmer

Research output: Contribution to journalArticleResearchpeer-review

3 Citations (Scopus)

Abstract

In this article, we consider fixed and floating strike European styleAsian call and put options. For such options, there is no convenient closed-form formula for the prices. Previously, Rogers and Shi, Vecer, and Dubois and Lelièvre have derived partial differential equations with one state variable, with the stock price as numeraire, for the option prices. In this paper, we derive a whole family of partial differential equations, each with one state variable with the stock price as numeraire, from which Asian options can be priced. Any one of these partial differential equations can be transformed into any other. This family includes four partial differential equations which have a particularly simple form including the three found by Rogers and Shi, Vecer, and Dubois and Lelièvre. Our analysis
includes the case of a dividend yield; we also include the case of in progress Asian options with floating strike, whereby we discuss the new equation proposed by Vecer, which uses the average asset as numeraire. We perform an error analysis on the four special partial differential equations and Vecer’s new equation and find that their truncation errors are all of the same order. We also
perform numerical comparisons of the five partial differential equations and conclude, as expected, that Vecer’s equations and that of Dubois and Lelièvre do better when the volatility is low but that with higher volatilities the performance of all five equations is similar. Vecer’s equations are unique in possessing a certain martingale property and as they perform numerically well or better than the others, must be considered the preferred choice.
Original languageEnglish
Pages (from-to)447-460
Number of pages14
JournalQuantitative Finance
Volume16
Issue number3
DOIs
Publication statusPublished - 2016

Keywords

  • Asian options
  • Partial differential equations
  • One state variable
  • Crank–Nicolson

Cite this

Brown, Christine Ann ; Handley, John ; Lin, C.-T. ; Palmer, Ken. / Partial differential equations for Asian option prices. In: Quantitative Finance. 2016 ; Vol. 16, No. 3. pp. 447-460.
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Partial differential equations for Asian option prices. / Brown, Christine Ann; Handley, John ; Lin, C.-T.; Palmer, Ken.

In: Quantitative Finance, Vol. 16, No. 3, 2016, p. 447-460.

Research output: Contribution to journalArticleResearchpeer-review

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