International Journal of Statistics and Applied Mathematics
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International Journal of Statistics and Applied Mathematics

2019, Vol. 4, Issue 6, Part A

Accurate option values of a nonlinear black-scholes equation with price slippage


Author(s): Collins Musera, Joseph Eyang`An Esekon and Onyango Fredrick

Abstract: Modern finance overlaps with many fields of mathematics, in particular, probability theory and stochastic processes. A nonlinear Black-Scholes Partial Differential Equation whose nonlinearity is as a result of transaction costs and a price slippage impact that lead to market illiquidity with feedback effects was studied. Most of the solutions obtained in option pricing especially using nonlinear equations are numerical which gives approximate option values. To get exact option values, analytic solutions for these equations have to be obtained. Analytic solutions to the nonlinear Black-Scholes Partial Differential Equation for pricing call and put options to expiry time are currently unknown. The main purpose of this paper was to obtain analytic solutions of European call and put options of a nonlinear Black-Scholes Partial Differential Equation with transaction costs and a price slippage impact. The methodology involved reduction of the equation into a second-order nonlinear Partial Differential Equation. By assumption of a traveling wave profile the equation was further reduced to Ordinary Differential Equations. Solutions to all the transformed equations gave rise to an analytic solution to the nonlinear Black-Scholes equation for a call option. Using the put-call parity relation the put option's value was obtained. The solutions obtained will be used to price put and call options in the presence of transaction costs and a price slippage impact. The solutions may also help in fitting the Black- Scholes option pricing model in the modern option pricing industry since it incorporates real world factors. In conclusion, it is clear that the time to expiry is the most critical for option-pricing models. The illiquid model in this paper admits to well-posed solutions of options on time to expiry because whilst remaining well-posed to expiry the option price behavior also remains sufficiently different from that of the corresponding liquid option. We have obtained efficient and accurate solutions for pricing European call and put options.

Pages: 48-52 | Views: 191 | Downloads: 5

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How to cite this article:
Collins Musera, Joseph Eyang`An Esekon, Onyango Fredrick. Accurate option values of a nonlinear black-scholes equation with price slippage. Int J Stat Appl Math 2019;4(6):48-52.
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