Pricing holder-extendable options in a stochastic volatility model with an Ornstein-Uhlenbeck process

• Main Authors: Ibrahim, Siti Nur Iqmal, Ng, Teck Wee, O'Hara, John G., Nawawi, A.
• Format: Article
• Language: English
• Published: Institute for Mathematical Research, Universiti Putra Malaysia 2017
• Online Access: http://psasir.upm.edu.my/id/eprint/51691/1/1.pdf; http://psasir.upm.edu.my/id/eprint/51691/; http://einspem.upm.edu.my/journal/fullpaper/vol11/1.pdf

Holder-extendable options are characterized by two maturity dates, which means the option can be exercised at either the expiration date or the extended maturity date. This paper develops a pricing framework for holder-extendable options which deals with the extended version of a stochastic volatility model with an Ornstein-Uhlenbeck (OU) process. The extended model allows correlation between volatility and asset returns. The method uses Fourier inversion techniques that does not require an initial guess of the characteristic functions. A closed-form pricing formula for holder-extendable options is derived for logarithmic asset price dynamics.