Find transition density functions (TDFs)

I use example 3-3 pages 11

use A form pages 8 (3.16a)

USE Function P (3.27) Form Pages 11

σ 2 S 2γ
Vt + VXX + rSVX − rV = 0 (1)
2
σ 2 S 2γ
Pt + PXX + rSPX = 0 (2)
2

β = σX Γ (3)

A = rx (4)

1 2 1
A0 + 2
A = r + 2 r 2 x2 (5)
σ σ

A = µx (6)
1 2 2
µ+ µ x = mx−2 + n (7)
c2
2
assume, β = µc2 , α = 0 and  = µ. so o function form pages 11 is best p i
can use for different γ

Find transition density functions (TDFs)

Part-A
We are interested in the solution for equation 3.16 for the case when {A(x) =
µx} . This corresponds to special values of the parameters. There is in
general a different solution for the density function corresponding to each
parameter. For A(x) = µx , the density function can be solved to give

0
    
1 1 µ x2−2γ e2(γ−1)µ(t−t ) +y 2−2γ 0
(γ−1)µ(t−t ) x1−γ y 1−γ
2µx y
2 2
−2γ
exp 0
c2 (γ−1)(e2(γ−1)µ(t−t ) −1)
I 1 (1−γ) − c2 2e−1+e2(γ−1)µ(t−t 0)
0
2 ( )(γ−1)
p(x, t; y, t ) = 2(γ−1)µ(t−t0 )
c2 (e − 1)
(8)

1
Part-B
p(x, t; y, t0 ) is plotted below for the case when γ = 0, 1/2, 1, 3/2 as a function
of y with x = 20, t = 0.1, t0 = 0, c = 0.1 and µ = 1/2.

1 Find Price for Call option

The price of call option is given by the equation

Z100
C(x, t) = e−r(T −t) (y − K)p(x, t; y, t0 )dy (9)
K=20

S r c γ Call

15 0.05 0.1 0 1.02116

17 0.04 0.2 0.5 1.02116
1
T = 12
20 0.03 0.3 1 0.995842
22 0.02 0.4 1.5 -1.73346
25 0.01 0.5 0 1.02116

15 0.05 0.1 0 1.01691

17 0.04 0.2 0.5 1.01691
2
T = 12
20 0.03 0.3 1 0.991701
22 0.02 0.4 1.5 -1.72625
25 0.01 0.5 0 1.01691

15 0.05 0.1 0 1.01268

17 0.04 0.2 0.5 1.01268
3
T = 12
20 0.03 0.3 1 0.987578
22 0.02 0.4 1.5 -1.71907
25 0.01 0.5 0 1.01268

2
2 Find Price for Put option
ZK
P (x, t) = e−r(T −t) (K − y)p(x, t; y, t0 )dy (10)
0

S r c γ Put

15 0.05 0.1 0 0
17 0.04 0.2 0.5 0
1
T = 12
20 0.03 0.3 1 0.995842
22 0.02 0.4 1.5 -0.712301
25 0.01 0.5 0 0

15 0.05 0.1 0 0
17 0.04 0.2 0.5 0
2
T = 12
20 0.03 0.3 1 0.991701
22 0.02 0.4 1.5 -0.709339
25 0.01 0.5 0 0

15 0.05 0.1 0 0
17 0.04 0.2 0.5 0
3
T = 12
20 0.03 0.3 1 0.987578
22 0.02 0.4 1.5 -0.706389
25 0.01 0.5 0 0

3 Proof of Equation 3.19

To prove equation 3.19, we have to first integrate
R A(x) R µx
x2γ dx = x2γ
dx
x2−2γ (11)
= µ 2(1−γ)
This will give

t0 − t
 
µx2−2γ 1
0 γ −
p(x, t; y, t ) = x e 2 c2 2(1−γ) z x1−γ , (12)
c(1 − γ) 2

3
 Now we must plug in the values α = 0 and β = µ2 /c2 and  = µ(1 − 2γ),
which means that

γ(γ − 2)
k1 = , k2 = −(1 − γ)2 µ2 , k3 = −µ(1 − 2γ) (13)
4(1 − γ)2
When these expressions are inserted for
√
k2 2
x
√
tan(2 k2 y)+k3 y
√ !
e 2 x tan(2 k2 y)
z(x, y) = p √ u √
, √ (14)
cos(2 k2 y) cos 2 k2 y 2 k2
Then it gives that
0
    
1 1 µ x2−2γ e2(γ−1)µ(t−t ) +y 2−2γ 0
(γ−1)µ(t−t ) x1−γ y 1−γ
2µx y 2 2
−2γ
exp 0
c2 (γ−1)(e2(γ−1)µ(t−t ) −1)
I 1 (1−γ) − c2 2e−1+e2(γ−1)µ(t−t 0)
0
2 ( )(γ−1)
p(x, t; y, t ) = 2(γ−1)µ(t−t0 )
c2 (e − 1)
(15)