The Russian Option with A Random Time Horizon

Abstract: This paper is intended to provide a unique valuation formula for the Russian option with a random time horizon; in particular, such option restricts its holders to make their stopping rules before the last exit time of the price of the underlying asset at its running maximum. By the theory of enlargement of filtrations associated with random times, this pricing problem can be transformed into an equivalent optimal stopping problem with a semi-continuous, time-dependent gain function whose partial derivative is singular at certain point. Despite these unpleasant features of the gain function, with our choice of the parameters, we establish the monotonicity of the free boundary and the regularity of the value function, which in turn lead us to the desired free-boundary problem. After this, the nonlinear integral equations that characterise the free boundary and the value function are derived. We also examine the solutions to these equations in details.