A lattice framework for pricing display advertisement options with the stochastic volatility underlying model

TL;DR

This paper introduces a lattice framework for pricing ad options using a stochastic volatility model, improving valuation accuracy for display advertising and enabling flexible delivery management for advertisers and increased revenue for publishers.

Contribution

It develops a novel lattice framework for ad option pricing under a stochastic volatility model, addressing limitations of previous GBM-based models.

Findings

SV model fits real data better than GBM

Lattice model validated by Monte Carlo simulations

Ad options provide flexible delivery management and revenue benefits

Abstract

Advertisement (abbreviated ad) options are a recent development in online advertising. Simply, an ad option is a first look contract in which a publisher or search engine grants an advertiser a right but not obligation to enter into transactions to purchase impressions or clicks from a specific ad slot at a pre-specified price on a specific delivery date. Such a structure provides advertisers with more flexibility of their guaranteed deliveries. The valuation of ad options is an important topic and previous studies on ad options pricing have been mostly restricted to the situations where the underlying prices follow a geometric Brownian motion (GBM). This assumption is reasonable for sponsored search; however, some studies have also indicated that it is not valid for display advertising. In this paper, we address this issue by employing a stochastic volatility (SV) model and discuss a lattice framework to approximate the proposed SV model in option pricing. Our developments are validated by experiments with real advertising data: (i) we find that the SV model has a better fitness over the GBM model; (ii) we validate the proposed lattice model via two sequential Monte Carlo simulation methods; (iii) we demonstrate that advertisers are able to flexibly manage their guaranteed deliveries by using the proposed options, and publishers can have an increased revenue when some of their inventories are sold via ad options.