An analytic pricing formula for timer options under constant elasticity of variance with stochastic volatility

Abstract

Timer options, which were first introduced by Société Générale Corporate and Investment Banking in 2007, are financial securities whose payoffs and exercise are determined by a random time associated with the accumulated realized variance of the underlying asset, unlike vanilla options exercised at the prescribed maturity date. In this paper, taking account of the correlation between the underlying asset price and volatility, we investigate the pricing of timer options under the constant elasticity of variance (CEV) model, proposed by Cox and Ross [10], taking advantage of the approach of asymptotic analysis. Additionally, we validate the pricing precision of the approximate formula for timer options using the Monte Carlo method. We conduct numerical experiments based on our corrected prices and analyze price sensitivities concerning various model parameters, with a focus on the value of elasticity.

Keywords

• timer options
• stochastic volatility
• constant elasticity of variance
• asymptotic analysis
• monte-carlo simulation