The well-known approximation formula by Barone-Adesi and Whaley (BAW) for pricing American options works well for contingent claims in the current business environment with low rates, but it lacks precision for pricing options when interest rates are high or in case of turmoil. In this paper, we introduce a new closed formula that is the solution of a non-autonomous PDE instead of the classical ODE. Our improved solution performs well in case of high turbulence allowing traders and risk managers to run stress tests with an appropriate model. This is complemented by an analytical approximation of the critical stock price S∗ as well as of the implied volatility. When a shock comes, it might be helpful to have the right model to deal with it.
An improved Barone-Adesi Whaley formula for turbulent markets
Bufalo M.;Orlando G.
Methodology
2022-01-01
Abstract
The well-known approximation formula by Barone-Adesi and Whaley (BAW) for pricing American options works well for contingent claims in the current business environment with low rates, but it lacks precision for pricing options when interest rates are high or in case of turmoil. In this paper, we introduce a new closed formula that is the solution of a non-autonomous PDE instead of the classical ODE. Our improved solution performs well in case of high turbulence allowing traders and risk managers to run stress tests with an appropriate model. This is complemented by an analytical approximation of the critical stock price S∗ as well as of the implied volatility. When a shock comes, it might be helpful to have the right model to deal with it.I documenti in IRIS sono protetti da copyright e tutti i diritti sono riservati, salvo diversa indicazione.
