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Volatility-Induced Bifurcation in Crank-Nicolson Option Pricing: Moneyness and Maturity Effects on Nigerian Equities ( )

Wokoma, Dagogo Allen and Amadi, Innocent Uchenna

Abstract

Crank-Nicolson (CN) finite difference schemes are industry standard for solving the Black- Scholes (BS) Partial Differential Equation , but their accuracy deteriorates in high- volatility regimes. We quantify CN pricing error for European call options using Nigerian equity parameters, CN systematically underprices calls, with relative error reaching 3.68% In-The-Money , 4.35% At-The-Money and 6.40% Out-of- The-Money at 65% volatility. The 1% error threshold defines a critical volatility * that falls from 45.5% for deep ITM to 30.1% for OTM, and from 43.1% at 6-months to 35.4% for 2-years LEAPS. Error scales as 2 2 C E S T ,confirming theoretical bounds. A 3D bifurcation surface in ( ) 0 , , / T K S space shows that all tested contracts breach 1% error before 50% = , a level routinely exceeded by Nigerian Exchange Group cement stocks during crises. At 65% volatility, a market maker selling 10,000ATM calls incurs an immediate $6.9M loss from underpricing. A bank holding 100000 calls understates Value-at-Risk by $77M , or 3.68%, falling Central Bank of Nigeria model-risk limits. We prove two theorems establishing that CN bias is structural, quadratic in volatility, and worse for OTM and long- dated options. To maintain 50bps accuracy, grid spacing must satisfy ( ) 0.15 / S T . For NGX risk management, we recommend adaptive grids or fourth-order compact schemes when 30% .

Keywords

Crank-NicolsonBlack-ScholesVolatility bifurcationNumerical errorNGXOption pricingVaRMoneyness and Maturity.

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