Barone-Adesi And Whaley Model

The Barone-Adesi and Whaley Model is a method for pricing exchange-traded American options, using quadratic approximation. Quadratic approximation is an extension of linear approximation. The Barone Adesi & Whaley Model is based on the Black-Scholes model and the Merton model. It uses an underlying asset and carrying cost rate as its key inputs. The model can be used to options on currencies, precious metals, long-term debt instruments with continuous coupon yields and stock indexes with continuous dividend yields.

Before Giovanni Barone-Adesi and Robert Whaley developed this American option pricing model, investors typically used finite-difference, binomial or compound-option approximation methods, which provide similar results but are more difficult and expensive to use. The Barone-Adesi and Whaley Model has the advantages of being fast, accurate and inexpensive to use. It is most accurate for options that will expire in less than one year.

The Black-Scholes Model is appropriate for European options, that is, options that may be exercised only on the expiration date. The Barone-Adesi and Whaley Model is designed for American options, which are options that may be exercised at any time before they expire. The Barone-Adesi and Whaley Model takes the value computed by the Black-Scholes Model and adds the value of the early exercise option that is available on American options.