Pricing barrier options with discrete dividends

TL;DR

This paper compares different analytical methods for pricing barrier options with discrete dividends, highlighting their effectiveness and limitations in complex financial scenarios.

Contribution

It evaluates and contrasts two analytical approaches for barrier option pricing in the presence of discrete dividends, expanding understanding of their relative performance.

Findings

Buryak and Guo's method effectively prices European options with discrete dividends.

Dai and Chiu's formulas are tailored for barrier options, offering alternative approximations.

Comparison reveals strengths and weaknesses of each approach in different market conditions.

Abstract

The presence of discrete dividends complicates the derivation and form of pricing formulas even for vanilla options. Existing analytic, numerical, and theoretical approximations provide results of varying quality and performance. Here, we compare the analytic approach, developed and effective for European puts and calls, of Buryak and Guo with the formulas, designed in the context of barrier option pricing, of Dai and Chiu.