Essays on derivatives pricing in financial engineering

Abstract

This thesis is written based on our investigations of derivatives pricing methods in the field of financial engineering. The first part proposes a closed-form asymptotic expansion approach to pricing discretely monitored Asian options in general one-dimensional diffusion models. Our expansion is a small-time expansion because the expansion parameter is selected to be the square root of the length of monitoring interval. This expansion method is distinguished from many other pricing-oriented expansion algorithms in the literature due to two appealing features. First, we illustrate that it is possible to explicitly calculate not only the first several expansion terms but also any general expansion term in a systematic way. Second, the convergence of the expansion is proved rigorously under some regularity conditions. Numerical experiments suggest that the closed-form expansion formula with only a few terms (e.g., four terms up to the third order) is accurate, fast, and easy to implement for a broad range of diffusion models, even including those violating the regularity conditions. The second part proposes an inversion algorithm with computable error bounds for two-dimensional, two-sided Laplace transforms. The algorithm consists of two discretization parameters and two truncation parameters. Based on the computable error bounds, we can select these parameters appropriately to achieve any desired accuracy. Hence this algorithm is particularly useful to provide benchmarks. In many cases, the error bounds decay quickly (e.g., exponentially), making the algorithm very efficient. We apply this algorithm to price exotic options such as spread options and barrier options under various asset pricing models, as well as to evaluate the joint cumulative distribution functions of related state variables. The numerical examples indicate that the inversion algorithm is accurate, fast and easy to implement.

Date of Award	2014
Original language	English
Awarding Institution	The Hong Kong University of Science and Technology