Graduation Year


Document Type




Degree Granting Department

Mathematics and Statistics

Major Professor

Professor Yuncheng You, Ph.D.

Committee Member

Wen-Xiu Ma, Ph.D.

Committee Member

Marcus McWaters, Ph.D.

Committee Member

Carol Williams, Ph.D.


Derivative pricing, Volatility, European option, American option, partial integro-differential equation, compound Poisson process, Fourier transform, Laplace transform, mean-reversion


Several existing pricing models of financial derivatives as well as the effects of volatility risk are analyzed. A new option pricing model is proposed which assumes that stock price follows a diffusion process with square-root stochastic volatility. The volatility itself is mean-reverting and driven by both diffusion and compound Poisson process. These assumptions better reflect the randomness and the jumps that are readily apparent when the historical volatility data of any risky asset is graphed. The European option price is modeled by a homogeneous linear second-order partial differential equation with variable coefficients. The case of underlying assets that pay continuous dividends is considered and implemented in the model, which gives the capability of extending the results to American options. An American option price model is derived and given by a non-homogeneous linear second order partial integro-differential equation. Using Fourier and Laplace transforms an exact closed-form solution for the price formula for European call/put options is obtained.