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On the one-sided maximum of Brownian and random walk fragments and its applications to new exotic options called “meander option”
Pacific Journal of Mathematics for Industry volume 6, Article number: 2 (2014)
We consider some distributions of one sided maxima of excursions and related variables for standard random walk and Brownian motion. We propose some new exotic options called meander options related to one of the fragments: the meander. We discuss the prices of meander options in a Black-Scholes market.
AMS Subject classification 60J55; 60J65; 91B28
1.1 Two-sided maxima for BW and RW
In our previous paper (), distributions of
were investigated where denotes Brownian Motion (written later as BM), whereas denotes a standard Random Walk (:RW), i.e: are i.i.d. and P(ξ1=1)=P(ξ1=−1)=1/2.
For , and is independent of BM, whereas in the RW case for , and θ∼ Geom (1−q) i.e: P(θ=k)=(1−q)qk for k) is independent of RW.
In our previous paper, we also discussed some relations between the functional equation for the Riemann zeta function and the maximum of Brownian excursion, as well as some infinite divisibility properties of d θ −g θ , i.e.:
where θ∼ Exp (m), which means that the length d θ −g θ of the excursion straddling θ is infinitely divisible and its Lévy Khintchin density is the Laplace transform of the arcsine law .
In this paper, instead of two-sided maxima, we shall consider one sided maxima for these fragments and investigate their distributions.
1.2 New exotic options called “Meander Option”
Using these mathematical results, we consider some application for mathemtical finance. We define “meander options”, the payoff of which is defined by the meander of stock value process above a strike price K before a maturity time T. For example,
Payoff of “meander lookback call option” where and S t is a stock value process, .
The financial meaning of meander lookback option is the following: If we consider a usual lookback option (with payoff: the price of this option is sometimes extremely high. So partial lookback option (with payoff: where is considered and sometimes traded. Meander lookback option is one example of this partial lookback option with closed price formula.
1.3 Self-explanatory tables for computations
We now present our results in the form of two self-explanatory Tables.
1.4 Organisation of our paper
In section 2, we indicate how to obtain the formulae for the distributions of the six maxima in Table 1, either for BM or for RW.
In section 3, we do the same for Table 2. In section 4, we apply some of the above results to get the price of the meander lookback option; to do this, we first compute at independent exponential time, then invert the Laplace transform.
Computations of distributions for the six maxima
Notation: For clarity, we write: P(Γ||Λ) for and P(Γ||X=x) for the conditional law of Γ, given X.
We start with:
since pre- g θ events and post- g θ events are independent. (see Revuz-, Chapter XII).Then, we get:
For random walk, we do similarly as with the preceding argument:
Then we get:
Clearly if , .Then we get:
Clearly if , .Then we get:
where we used the following facts:
and we see that
Computations of joint distributions
where we put , and X∼Y∼E x p(λ), X and Y are independent.
since pre- g θ events and post- g θ events are independent. (see Revuz -Yor, Chapter XII).
We start with:
since pre- g θ events and post- g θ events are independent.
Then, we get:
by the Markov property at θ.
If x>A, the result is trivially 0.
In the following section, we state applications of these exact computations to price some exotic options which we call “Meander Options”.
Price of some meander options
4.1 Option price at independent exponential time
We consider the following Black Scholes Model under the risk neutral measure Q:
where S t is the stock value at time t, r is the risk free rate, and σ is the volatility.We get:
Then the risk neutral valuation for derivative with payoff Y at maturity time T gives V0(Y), the present value of derivative Y:
If Y is of the form ϕ(F T ), instead of fixed time T, it may be more convenient to work at time θ, an independent exponential time, because using such θ often makes expressions simpler than at fixed time T.
There are 2 ways to access such results.
to obtain the law of F t ;
in fact, very often for this, it is simpler to consider F θ , θ∼Exp(λ), and to invert the Laplace transform to get the law of F t . Then, compute E(ϕ(F t )) for the particular ϕ of interest.
second attitude: Start directly with(33)
and invert the Laplace transform.
In fact, there is the commutative diagram:
which indicates that we may use either route from NW to SE.
First we consider the case ϕ=f(S T ) which is only dependent on the final stock value S T .
Generally we get that where we used that for .
We also used the simple facts then, we get
In the case of a call option, f(S T )=(S T −K)+. We want to get the call option price when .
We get the usual Black-Scholes formula by inverting the above with respect to λ.
4.2 Price of meander lookback option
In the following, we calculate the above in two cases: a) and b)
For call option i.e. f(x)=(x−K)+, we obtain that by some elementary calculation,
a) when , the price equals:
Especially, if σ2=2r, the price equals .
b) when , the price equals: .
Prof. Marc Yor passed away suddenly on January 9 2014. He brought so many gifts to our mathematics. We will never forget him.
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Fujita, T., Kawanishi, Y. & Yor, M. On the one-sided maximum of Brownian and random walk fragments and its applications to new exotic options called “meander option”. Pac. J. Math. Ind. 6, 2 (2014). https://doi.org/10.1186/s40736-014-0002-0
- Standard random walk
- Standard Brownian motion
- Exotic option
- Black Scholes market