Asymptotic analysis of options in a jump-diffusion model with binomial jump size distribution (Q1950176)

Summary: We provide an asymptotic analysis of European and American call options in a jump-diffusion model for a single-asset market, where the jump size follows a binomial distribution \(B(n, p)\) for \(n\geq 1\) and \(p\in ]0, 1[\), and the volatility is small compared to the drift terms. An asymptotic formula for the perpetual call option for small volatility is also developed. It is showed that at leading order, the American call option, behaves in the same manner as a perpetual call, except in a boundary layer about the option's expiry date. Next, we apply the obtained asymptotic results to approximate the same options in the Merton's model. Precisely, we approximate the jump size normal distribution by a discrete binomial one for large number n, on the basis of the central limit theorem. Then, we use for small volatility, the binomial asymptotic expansion formulas to approximate European and American call prices, in the Merton's model. Finally, the found expansion formulas for call prices are illustrated graphically. They represent a powerful tool for approximating option prices with a good accuracy. We think that these formulas contribute to the theory of option pricing.