Perpetual American options in a diffusion model with piecewise-linear coefficients

Pavel V. Gapeev and Neofytos Rodosthenous
  • London School of Economics, Department of Mathematics, London, Großbritannien

Abstract

We derive closed form solutions to the discounted optimal stopping problems related to the pricing of the perpetual American standard put and call options in an extension of the Black–Merton–Scholes model with piecewise-constant dividend and volatility rates. The method of proof is based on the reduction of the initial optimal stopping problems to the associated free-boundary problems and the subsequent martingale verification using a local time-space formula. We present explicit algorithms to determine the constant hitting thresholds for the underlying asset price process, which provide the optimal exercise boundaries for the options.

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Statistics & Risk Modeling publishes articles that discuss modern methods of statistics and probabilistic modeling and their applications to risk management in finance, insurance, and related areas. It also welcomes papers that present methodological innovations in statistical theory as well as papers on innovative statistical modeling applications and inference in risk management.

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