I am trying to understand how Fourier transforms & Characteristics functions can be used to calculate option values.
However, I am having difficulty following the process that is used in several introductory papers like: Carr & Madam, Liuren Wu, Schmelze or Chourdakis (chapter 4)
In order to obtain an intuitive understanding of this method, it will be very helpful if someone could provide me with an example on how to calculate option prices using this pricing technique.
Since this is not homework, any intuitive example will be greatly appreciated.
EDIT: as a potential example, consider that we want to estimate the fair value of an European call option struck at $K = 12$ and with time to maturity $T = 2$ years. The underlying asset $S$ has initial price $S_0 = 10$ and its returns volatility is $\sigma = 0.25$. The risk free rate is $r = 0.05$.
For the previous example, the Black-Scholes equation indicates that the option fair value should be $1.07$. How can I reproduce this result using Fourier transforms?
No comments:
Post a Comment