Journal of Applied Mathematics

Volume 2013 (2013), Article ID 352021, 6 pages

http://dx.doi.org/10.1155/2013/352021

Research Article

Asian Option Pricing with Monotonous Transaction Costs under Fractional Brownian Motion

Di Pan, Shengwu Zhou, Yan Zhang, and Miao Han

College of Sciences, China University of Mining and Technology, Jiangsu, Xuzhou 221116, China

Received 27 September 2013; Accepted 26 November 2013

Academic Editor: Song Cen

Copyright © 2013 Di Pan et al. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

Abstract.

Geometric-average Asian option pricing model with monotonous transaction cost rate under fractional Brownian motion was established. The method of partial differential equations was used to solve this model and the analytical expressions of the Asian option value were obtained. The numerical experiments show that Hurst exponent of the fractional Brownian motion and transaction cost rate have a significant impact on the option value.

1. Introduction

In 1989, Peters [1] firstly proposed that fractional Brownian motion could be used to describe the changes of asset prices. In 2000, the theory of stochastic integral about fractional Brownian motion was studied by Duncan et al. [2], and fractional Itô’s formula and Girsanov theorem under the fractional Brownian motion were derived. The fractional Itô’s integral had been further developed by Biagini et al. [3] for . Equivalent definition of fractional Itô’s integral was introduced by Alos et al. [4] and Bender [5]. Necula [6] utilized the knowledge of fractal geometry and deduced the Black-Scholes option pricing formula under fractional Brownian motion, which was of great significance to the development of option pricing with fractional Brownian motion. The transaction cost is an important factor affecting the option pricing. Many scholars had studied the pricing problems of contingent claim with transaction costs. Leland [7] groundbreakingly proposed that a modified volatility should be applied to solving the problem of hedging error brought by transaction costs in Black-Scholes model. Barles and Soner [8] assumed that the investor’s preference satisfied exponential utility function and provided a more complex model. The Black-Scholes option pricing model with transaction costs was given by Amster et al. [9]. Liu and Chang [10] and Wang et al. [11] studied the European option pricing with transaction costs under the fractional Brownian motion. The pricing studies for the Asian option mostly are based on the standard Brownian motion, but the time-varying of Asian option pricing model under fractional Brownian motion had not been studied systematically.

Based on the previous references, the geometric Asian option pricing model with monotonous transaction rates under the fractional Brownian motion was presented, and the analytic expression of the Asian option value was derived. The influence of Hurst exponent and transaction cost on the Asian option value was discussed through the numerical calculations.

This paper’s outline is as follows. In Section 2, we studied the geometric-average Asian option pricing model under the fractional Brownian motion. The closed-form solution of the pricing model was presented in Section 3. In Section 4, the numerical examples were given. Section 5 serves as the conclusion of the whole paper.

2. Geometric-Average Asian Option Pricing Model for a Fractional Brownian Motion under Monotonous Transaction Cost Rate

Let be a complete probability space carrying a fractional Brownian motion with Hurst exponent , that is, a continuous, centered Gaussian process with covariance function [12]

If , then the corresponding fractional Brownian motion is the usual standard Brownian motion.

In this paper we will drive a geometric-average Asian option pricing model under the following assumptions.

(i)The price of the underlying stock satisfies

where is the expected yields, is the stock price volatility, and is the fractional Brownian motion with Hurst exponent.(ii)The risk-free interest rate is a deterministic function of time .(iii)Suppose shares of the underlying stock are bought or sold at the price ; then the transaction cost is given by in either buying or selling; here is a monotone transaction cost rate.(iv)The expected return rate of the portfolio equals the risk-free interest rate.(v)The portfolio is revised every , where is a finite and fixed small time step.

Let be the value of the geometric-average Asian call option on the time , where is the geometric average of the underlying asset price in the time period of .

Construct a portfolio : long position of a Geometric-average Asian call option and short position of shares of underlying asset. Then the value of the portfolio at current time is

In the period , the change in the value of the portfolio is

where

Owing to

we have

hence we have

By the assumption (iv) we have

And then

Owing to

then

Choosing and substituting it into (10), the following formula can be obtained:

Let

Substituting these into (13), we get the following conclusions.

Theorem 1. If the underlying asset price satisfies fractional Brownian motion (2), then the value of Geometric-average Asian call option with monotonous transaction cost rate at the time satisfies the following mathematical model:

Remark 2. For a single European option with long position, the yield at expiration date is or . Because they are convex functions, . Due to , thus . Then (14) can be represented as

3. Option Pricing Formulas

Theorem 3. Supposing the underlying asset prices satisfy (2), then at time the value of Geometric-average Asian call option with transaction costs with expiration date and exercise price is as follows:

where

Proof. Let

then

Hence model (15) can be transformed into

Let

which satisfies the conditions ; then we have

Substituting (23) into (21), we have

Let

and combined with terminal conditions , we can get

Thus (21) becomes

According to the theory of classical heat conduction equation solution, we have

Let

then

By variable restored, we obtain that

So the value of geometric-average Asian call option on the time is

Corollary 4. If the riskless interest and the volatility are constant, then the values and of Geometric-average Asian call option and put option respectively with monotonous transaction cost at time with expiration date and exercise price are

where

and the remaining symbols accord with Theorem 3.

4. Numerical Experiments

In this section, the influence of monotone transaction rate parameters and the Hurst exponent on Asian option value will be discussed through applying MATLAB software. The values of the parameters of geometric-average Asian options are assumed as follows:

With the option pricing formulas (33) presented, the value of the option can be calculated. Figures 1 and 2 give the relationships between the price of the underlying assets and the value of Asian call option and put option with different Hurst exponent. From the figures, Hurst exponent is inversely proportional to the value of Asian option. Figures 3 and 4 demonstrate the changes of Asian call option with the stock price under the different parameter and parameter . We can draw such a conclusion: the option value increases with the parameter increasing and decreases with the parameter increasing. This is mainly because transaction cost rate is a decreasing function of and an increasing function of .

Figure 1: Asian call option pricing corresponding to the different .

Figure 2: Asian put option pricing corresponding to the different .

Figure 3: Asian put option pricing corresponding to the different .

Figure 4: Asian put option pricing corresponding to the different .

5. Discussions and Conclusions

In this paper, the problem of Asian option pricing with monotonous transaction cost rate under fractional Brownian motion was studied by using the portfolio technology and no arbitrage principle, and the pricing model was established. This model was solved by the method of partial differential equations, and the analytical expressions of the Asian option value were obtained. The numerical experiments showed that Hurst exponent of the fractional Brownian motion and transaction cost rates have a significant impact on the option value.

Conflict of Interests

The authors declare that they have no conflict of interests.

Acknowledgment

This work is supported by the Fundamental Research Funds for the Central Universities (2013XK03).

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