Physics – Condensed Matter – Other Condensed Matter
Scientific paper
2004-04-05
Physics
Condensed Matter
Other Condensed Matter
24 pages
Scientific paper
We solve the pricing problem for perpetual American puts and calls on dividend-paying assets. The dependence of a dividend process on the underlying stochastic factor is fairly general: any non-decreasing function is admissible. The stochastic factor follows a Levy process. This specification allows us to consider assets that pay no dividends at all when the level of the underlying factor (say, the assets of the firm) is too low, and assets that pay dividends at a fixed rate when the underlying stochastic process remains in some range. Certain dividend processes exhibiting mean-reverting features can be modelled as appropriate increasing functions of Levy processes. The payoffs of both the American put and call options can be represented as the expected present value (EPV) of a certain stream of dividends, and we show that the option must be exercised the first time the EPV of this stream with the original process being replaced by the infimum process starting from the current level, becomes positive. Thus, the exercise threshold depends only on the record setting bad news. The results can be applied to the theory of real options as well; as one of possible applications, we consider the problem of incremental capital expansion.
Boyarchenko Svetlana
Levendorskii Sergei
No associations
LandOfFree
Universal bad news principle and pricing of options on dividend-paying assets does not yet have a rating. At this time, there are no reviews or comments for this scientific paper.
If you have personal experience with Universal bad news principle and pricing of options on dividend-paying assets, we encourage you to share that experience with our LandOfFree.com community. Your opinion is very important and Universal bad news principle and pricing of options on dividend-paying assets will most certainly appreciate the feedback.
Profile ID: LFWR-SCP-O-666592