A mathematical modeling for the lookback option with jump-diffusion using binomial tree method

Abstract

The binomial tree method (BTM), first proposed by Cox et al. (1979) [4] in diffusion models and extended by Amin (1993) [9] to jump-diffusion models, is one of the most popular approaches to pricing options. In this paper, we present a binomial tree method for lookback options in jump-diffusion models and show its equivalence to certain explicit difference scheme. We also prove the existence and convergence of the optimal exercise boundary in the binomial tree approximation to American lookback options and give the terminal value of the genuine exercise boundary. Further, numerical simulations are performed to illustrate the theoretical results. (C) 2011 Elsevier B.V. All rights reserved.