Indifference pricing for contingent claims: large deviations effects

DOI10.1111/MAFI.12137MaRDI QIDQ4635044zbMATH OpenOpenAlexFDO

Authors Scott Robertson, Konstantinos Spiliopoulos

Publication date 13 April 2018

Published in Mathematical Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1410.0384

zbMATH Keywords

incomplete marketindifference pricelarge deviations theoryoptimal positionsvanishing hedging error

Mathematics Subject Classification ID

Large deviations (60F10) Martingales with continuous parameter (60G44) Portfolio theory (91G10)

Abstract: We study utility indifference prices and optimal purchasing quantities for a non-traded contingent claim in an incomplete semi-martingale market with vanishing hedging errors. We make connections with the theory of large deviations. We concentrate on sequences of semi-complete markets where in the $n^{th}$ market, the claim $B_n$ admits the decomposition $B_n=D_n+Y_n$. Here, $D_n$ is replicable by trading in the underlying assets $S_n$, but $Y_n$ is independent of $S_n$. Under broad conditions, we may assume that $Y_n$ vanishes in accordance with a large deviations principle as $n$ grows. In this setting, for an exponential investor, we identify the limit of the average indifference price $p_n(q_n)$, for $q_n$ units of $B_n$, as $nightarrowinfty$. We show that if $|q_n|ightarrowinfty$, the limiting price typically differs from the price obtained by assuming bounded positions $su{p}_n|q_n|<infty$, and the difference is explicitly identifiable using large deviations theory. Furthermore, we show that optimal purchase quantities occur at the large deviations scaling, and hence large positions arise endogenously in this setting.

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Cited in

(5)

• The pricing of contingent claims and optimal positions in asymptotically complete markets
• Indifference price with general semimartingales
• Pricing for large positions in contingent claims
• Pricing of contingent claims in large markets
• Representation of indifference prices on a finite probability space

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