UCLA Recent Work Title "The perpetual American put option for jump-diffusions with applications" Publication Date The perpetual American put option for jump-diffusions with applications

Knut Aase
2005 unpublished
In this paper we solve an optimal stopping problem with an infinite time horizon, when the state variable follows a jump-diffusion. Under certain conditions our solution can be interpreted as the price of an American perpetual put option, when the underlying asset follows this type of process. We present several examples demonstrating when the solution can be interpreted as a perpetual put price. This takes us into a study of how to risk adjust jump-diffusions. One key observation is that the
more » ... ation is that the probability distribution under the risk adjusted measure depends on the equity premium, which is not the case for the standard, continuous version. This difference may be utilized to find intertemporal, equilibrium equity premiums, for example. Our basic solution is exact only when jump sizes can not be negative. We investigate when our solution is an approximation also for negative jumps. Various market models are studied at an increasing level of complexity, ending with the incomplete model in the last part of the paper.
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