Pricing timer options: second-order multiscale stochastic volatility asymptotics
Keywords:timer option, stochastic volatility, implied volatility, multiscale asymptotics , singular perturbation
We study the pricing of timer options in a class of stochastic volatility models, where the volatility is driven by two diffusions—one fast mean-reverting and the other slowly varying. Employing singular and regular perturbation techniques, full second-order asymptotics of the option price are established. In addition, we investigate an implied volatility in terms of effective maturity for the timer options, and derive its second-order expansion based on our pricing asymptotics. A numerical experiment shows that the price approximation formula has a high level of accuracy, and the implied volatility in terms of its effective maturity is illustrated.
Special Issue for Financial Mathematics, Probability and Statistics