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American type geometric step options

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  • The step option is a special contact whose value decreases gradually in proportional to the spending time outside a barrier of the asset price. European step options were introduced and studied by Linetsky [11] and Davydov et al. [2]. This paper considers American step options, including perpetual case and finite expiration time case. In perpetual case, we find that the optimal exercise time is the first crossing time of the optimal level. The closed price formula for perpetual step option could be derived through Feynman-Kac formula. As for the latter, we present a system of variational inequalities satisfied by the option price. Using the explicit finite difference method we could get the numerical option price.
    Mathematics Subject Classification: Primary: 91B25; Secondary: 60G40.


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