A generalization of option pricing to price-limit markets

Jia-Hau Guo*, Lung Fu Chang

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

Abstract

This paper proposes an analytic solution for pricing options in markets with daily price limits. The Black–Scholes model is a nested case in which the daily price limit approaches infinity. Compared to the Black–Scholes model, our solution may solve the mispricing problem and could yield consistent results with existing numerical methods. Practitioners trading options in price-limit markets may resort to the finite difference method or Monte Carlo simulations. However, applying these numerical methods is often time consuming, thereby further illustrating the importance of an analytic solution.

Original languageEnglish
JournalReview of Derivatives Research
DOIs
StatePublished - Jul 2020

Keywords

  • Analytic solution
  • Backward equation
  • Characteristic function
  • Daily price limit
  • Fast Fourier transform
  • Local times

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