An explicit closed-form analytical solution for European options under the CGMY model

• The pricing of European options is considered under the CGMY model.
• A closed-form analytical solution is derived from the fractional partial differential equation system by using the fractional calculus theory.
• Numerical method is also proposed for the implementation of the derived formula.

In this paper, we consider the analytical pricing of European path-independent options under the CGMY model, which is a particular type of pure jump Le´vy process, and agrees well with many observed properties of the real market data by allowing the diffusions and jumps to have both finite and infinite activity and variation. It is shown that, under this model, the option price is governed by a fractional partial differential equation (FPDE) with both the left-side and right-side spatial-fractional derivatives. In comparison to derivatives of integer order, fractional derivatives at a point not only involve properties of the function at that particular point, but also the information of the function in a certain subset of the entire domain of definition. This “globalness” of the fractional derivatives has added an additional degree of difficulty when either analytical methods or numerical solutions are attempted. Albeit difficult, we still have managed to derive an explicit closed-form analytical solution for European options under the CGMY model. Based on our solution, the asymptotic behaviors of the option price and the put-call parity under the CGMY model are further discussed. Practically, a reliable numerical evaluation technique for the current formula is proposed. With the numerical results, some analyses of impacts of four key parameters of the CGMY model on European option prices are also provided.