Journal Article10.1111/J.1540-6261.1985.TB02383.X
Option Pricing and Replication with Transactions Costs
TL;DR: In this paper, a modified option replicating strategy which depends on the size of transactions costs and the frequency of revision was developed, which permits calculation of the transactions costs of option replication and provides bounds on option prices.
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Abstract: Transactions costs invalidate the Black-Scholes arbitrage argument for option pricing, since continuous revision implies infinite trading. Discrete revision using Black-Scholes deltas generates errors which are correlated with the market, and do not approach zero with more frequent revision when transactions costs are included. This paper develops a modified option replicating strategy which depends on the size of transactions costs and the frequency of revision. Hedging errors are uncorrelated with the market and approach zero with more frequent revision. The technique permits calculation of the transactions costs of option replication and provides bounds on option prices.
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Citations
Market Making in the Options Markets and the Costs of Discrete Hedge Rebalancing
Mel Jameson,William J. Wilhelm +1 more
TL;DR: In this paper, the authors provide empirical evidence consistent with the hypothesis that options market makers face risks in managing inventory that are unique to the options markets and show that risks associated with the inability to rebalance an option position continuously and uncertainty about the return volatility of the underlying stock each account for a statistically and economically significant proportion of the bid-ask spreads quoted for a sample of Chicago Board Options Exchange options.
106
Pricing Dynamic Insurance Risks Using the Principle of Equivalent Utility
TL;DR: In this paper, an expected utility approach is proposed to price insurance risks in a dynamic financial market setting. But this approach relies heavily on risk preferences and yields two reservation prices -one each for the underwriter and buyer of the contract.
104
Optimal Replication of Contingent Claims under Portfolio Constraints
TL;DR: In this paper, the authors determine the minimum cost of superreplicating a nonnegative contingent claim when there are convex constraints on portfolio weights and show that the optimal cost with constraints is equal to the price of a related claim without constraints.
104
On the risk-adjusted pricing-methodology-based valuation of vanilla options and explanation of the volatility smile
Martin Jandačka,Daniel Sevcovic +1 more
TL;DR: In this paper, a model for pricing derivative securities in the presence of both transaction costs as well as the risk from a volatile portfolio is proposed, where transaction costs are described following the Hoggard, Whalley, and Wilmott approach.
Optimal portfolio management with transactions costs and capital gains taxes
TL;DR: In this article, the optimal trading strategy for an investment fund which in the absence of transactions costs would like to maintain assets in exogenously fixed proportions, e.g. 60/30/10 in stocks, bonds and cash, was examined.
References
The Pricing of Options and Corporate Liabilities
Fischer Black,Myron S. Scholes +1 more
TL;DR: In this paper, a theoretical valuation formula for options is derived, based on the assumption that options are correctly priced in the market and it should not be possible to make sure profits by creating portfolios of long and short positions in options and their underlying stocks.
31.9K
An introduction to probability theory and its applications - 3/E. volume 3
William Feller
- 22 Mar 2002
Abstract: The classic text for understanding complex statistical probability An Introduction to Probability Theory and Its Applications offers comprehensive explanations to complex statistical problems. Delving deep into densities and distributions while relating critical formulas, processes and approaches, this rigorous text provides a solid grounding in probability with practice problems throughout. Heavy on application without sacrificing theory, the discussion takes the time to explain difficult topics and how to use them. This new second edition includes new material related to the substitution of probabilistic arguments for combinatorial artifices as well as new sections on branching processes, Markov chains, and the DeMoivreLaplace theorem.
21.5K
The Valuation of Uncertain Income Streams and the Pricing of Options
TL;DR: In this paper, a simple formula for the valuation of uncertain income streams consistent with rational risk averse investor behavior and equilibrium in financial markets is developed for the pricing of an option as a function of its associated stock.
1.6K