Valuation of installment option by penalty method

Document Type : Research Paper


Faculty of Mathematical Sciences, University of Tabriz, Tabriz, Iran


In this paper, installment options on the underlying asset which evolves according to Black-Scholes model and pays constant dividend to its owner will be considered. Applying arbitrage pricing theory, the non-homogeneous parabolic partial differential equation governing the value of installment option is derived. Then, penalty method is used to value the European continuous installment call option.