226
Views
0
CrossRef citations to date
0
Altmetric
Section B

Numerical analysis for Spread option pricing model of markets with finite liquidity: first-order feedback model

, , &
Pages 2603-2620 | Received 20 Feb 2013, Accepted 21 Jan 2014, Published online: 27 Mar 2014
 

Abstract

In this paper, we discuss the numerical analysis and the pricing and hedging of European Spread options on correlated assets when, in contrast to the standard framework and consistent with a market with imperfect liquidity, the option trader's trading in the stock market has a direct impact on one of the stocks price. We consider a first-order feedback model which leads to a linear partial differential equation. The Peaceman–Rachford scheme is applied as an alternating direction implicit method to solve the equation numerically. We also discuss the stability and convergence of this numerical scheme. Finally, we provide a numerical analysis of the effect of the illiquidity in the underlying asset market on the replication of an European Spread option; compared to the Black–Scholes case, a trader generally buys less stock to replicate a call option.

2010 AMS Subject Classifications:

Work supported by NSERC grant 5-36700, SSHRC grant 5-26758 and MITACS grant 5-26761 (T.A.P.).

Reprints and Corporate Permissions

Please note: Selecting permissions does not provide access to the full text of the article, please see our help page How do I view content?

To request a reprint or corporate permissions for this article, please click on the relevant link below:

Academic Permissions

Please note: Selecting permissions does not provide access to the full text of the article, please see our help page How do I view content?

Obtain permissions instantly via Rightslink by clicking on the button below:

If you are unable to obtain permissions via Rightslink, please complete and submit this Permissions form. For more information, please visit our Permissions help page.