Rodosthenous, Neofytos
(2013)
Optimal stopping problems in mathematical finance.
PhD thesis, The London School of Economics and Political Science.
Abstract
This thesis is concerned with the pricing of Americantype contingent claims. First, the explicit solutions to the perpetual American compound option pricing problems in the BlackMertonScholes model for financial markets are presented. Compound options are financial contracts which give their holders the right (but not the obligation) to buy or sell some other options at certain times in the future by the strike prices given. The method of proof
is based on the reduction of the initial twostep optimal stopping problems for the underlying geometric Brownian motion to appropriate sequences of ordinary onestep problems. The latter are solved through their associated onesided freeboundary problems and the subsequent martingale verification for ordinary differential operators. The closed form solution to the perpetual
American chooser option pricing problem is also obtained, by means of the analysis of the equivalent twosided freeboundary problem. Second, an extension of the BlackMertonScholes model with piecewiseconstant dividend
and volatility rates is considered. The optimal stopping problems related to the pricing of the perpetual American standard put and call options are solved in closed form. The method of proof is based on the reduction of the initial optimal stopping problems to the associated freeboundary problems and the subsequent martingale verification using a local timespace formula. As a result, the explicit algorithms determining the constant hitting thresholds for the underlying asset price process, which provide the optimal exercise boundaries for the options,
are presented. Third, the optimal stopping games associated with perpetual convertible bonds in an extension of the BlackMertonScholes model with random dividends under different information flows are studied. In this type of contracts, the writers have a right to withdraw the bonds
before the holders can exercise them, by converting the bonds into assets. The value functions and the stopping boundaries' expressions are derived in closedform in the case of observable dividend rate policy, which is modelled by a continuoustime Markov chain. The analysis of the associated parabolictype freeboundary problem, in the case of unobservable dividend rate policy, is also presented and the optimal exercise times are proved to be the first times at which the asset price process hits boundaries depending on the running state of the filtering dividend rate estimate. Moreover, the explicit estimates for the value function and the optimal exercise boundaries, in the case in which the dividend rate is observable by the writers but unobservable by the holders of the bonds, are presented. Finally, the optimal stopping problems related to the pricing of perpetual American options in an extension of the BlackMertonScholes model, in which the dividend and volatility rates of the underlying risky asset depend on the running values of its maximum and its maximum
drawdown, are studied. The latter process represents the difference between the running maximum and the current asset value. The optimal stopping times for exercising are shown to be the first times, at which the price of the underlying asset exits some regions restricted by
certain boundaries depending on the running values of the associated maximum and maximum drawdown processes. The closedform solutions to the equivalent freeboundary problems for the value functions are obtained with smooth fit at the optimal stopping boundaries and normal reflection at the edges of the state space of the resulting threedimensional Markov process. The optimal exercise boundaries of the perpetual American call, put and strangle options are obtained as solutions of arithmetic equations and firstorder nonlinear ordinary differential equations.
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