Local time and the pricing of time-dependent barrier options

13 years 3 months ago

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Abstract A time-dependent double-barrier option is a derivative security that delivers the terminal value φ(ST ) at expiry T if neither of the continuous time-dependent barriers b± : [0,T ] → R+ have been hit during the time interval [0,T ]. Using a probabilistic approach, we obtain a decomposition of the barrier option price into the corresponding European option price minus the barrier premium for a wide class of payoff functions φ, barrier functions b± and linear diffusions (St )t∈[0,T ]. We show that the barrier premium can be expressed as a sum of integrals along the barriers b± of the option’s deltas Δ± : [0,T ] → R at the barriers and that the pair of functions (Δ+,Δ−) solves a system of Volterra integral equations of the ﬁrst kind. We ﬁnd a semi-analytic solution for this system in the case of constant double barriers and brieﬂy discus a numerical algorithm for the time-dependent case. Keywords Time-dependent single- and double-barrier options · Local ...

Aleksandar Mijatovic

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