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Original Articles

Analytical approximation method of option pricing under geometric mean-reverting process

Pages 1082-1092 | Received 24 Nov 2008, Accepted 08 Feb 2009, Published online: 01 Jun 2009
 

Abstract

This paper is concerned with analytical approximation for option pricing while the underlying asset price follows a geometric mean-reverting diffusion process, which is often used in real and commodity options. Two methods are developed, one employing the idea of Edgeworth series expansion and another based on Taylor series expansion. Numerical tests show that the second method significantly outperforms the first one, particularly for long-maturity options. In addition, we compare the analytical approximation prices with that obtained using an alternative log-normal model for commodities and find out for many cases the discrepancy in option prices is remarkable.

2000 AMS Subject Classifications :

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