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.
read more
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.
read more
Chat with Paper
AI Agents for this Paper
Find similar papers on Google Scholar, PubMed and Arxiv
Write a critical review of this paper
Analyze citations of this paper to find unaddressed research gaps
Citations
•Posted Content
Static Hedging of Multivariate Derivatives by Simulation
TL;DR: It is shown that, in the presence of transaction costs, Value at Risk and Expected Shortfall of the dynamically hedged positions can be higher than the ones obtained by a static hedge.
1
Portfolio insurance for foreign exchange risk management
TL;DR: In this article, the authors evaluated and compared hedging alternatives that employ currency forward or futures contracts, finding no significant differences for the Deutschmark or British pound, but superior forward hedging for the Japanese yen.
1
Pricing Options With Price Limits and Market Illiquidity
Chuang Chang Chang,Huimin Chung,Tin I. Wang +2 more
- 01 Jan 2005
TL;DR: In this article, the authors developed models to value options for the cases of either the underlying assets encountering price limits and market illiquidity, or when the underlying asset are imposed with price limits.
1
Exotic option pricing model of the Black–Scholes formula: a proactive investment strategy
TL;DR: In this article , an exotic option with a proactive investment strategy was proposed, where the option holders continuously trade the underlying assets according to a predetermined investment strategy and the specific pricing expression of the exotic option was derived from the Black-Scholes option pricing formula.
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