Classes of elementary function solutions to the CEV model. I

TL;DR

This paper systematically derives elementary function solutions for the CEV model's differential equations using Kovacic's algorithm, revealing new classes of solutions for specific parameter values, expanding analytical options in option pricing.

Contribution

It provides a systematic derivation of elementary solutions to the CEV model for half-integer elasticity parameters, extending analytical solutions beyond traditional models.

Findings

Identifies four classes of solutions for specific b values

Derives solutions for b=-1/2 and b=1/2 with two classes each

Obtains elementary solutions for b=0, including dividend considerations

Abstract

The CEV model subsumes some of the previous option pricing models. An important parameter in the model is the parameter b, the elasticity of volatility. For b=0, b=-1/2, and b=-1 the CEV model reduces respectively to the BSM model, the square-root model of Cox and Ross, and the Bachelier model. Both in the case of the BSM model and in the case of the CEV model it has become traditional to begin a discussion of option pricing by starting with the vanilla European calls and puts. In the case of BSM model simpler solutions are the log and power solutions. These contracts, despite the simplicity of their mathematical description, are attracting increasing attention as a trading instrument. Similar simple solutions have not been studied so far in a systematic fashion for the CEV model. We use Kovacic's algorithm to derive, for all half-integer values of b, all solutions "in quadratures" of the CEV ordinary differential equation. These solutions give rise, by separation of variables, to simple solutions to the CEV partial differential equation. In particular, when b=...,-5/2,-2,-3/2,-1, 1, 3/2, 2, 5/2,..., we obtain four classes of denumerably infinite elementary function solutions, when b=-1/2 and b=1/2 we obtain two classes of denumerably infinite elementary function solutions, whereas, when b=0 we find two elementary function solutions. In the derived solutions we have also dispensed with the unnecessary assumption made in the the BSM model asserting that the underlying asset pays no dividends during the life of the option.