American options under proportional transaction costs: pricing, hedging and stopping algorithms for long and short positions

DOI10.1007/S10440-008-9290-7MaRDI QIDQ1028005zbMATH OpenOpenAlexFDO

Authors Alet Roux, Tomasz Zastawniak

Publication date 30 June 2009

Published in Acta Applicandae Mathematicae (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/0709.1589

zbMATH Keywords

transaction costsAmerican optionssuperhedgingrandomised stopping

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Stopping times; optimal stopping problems; gambling theory (60G40)

Abstract: American options are studied in a general discrete market in the presence of proportional transaction costs, modelled as bid-ask spreads. Pricing algorithms and constructions of hedging strategies, stopping times and martingale representations are presented for short (seller's) and long (buyer's) positions in an American option with an arbitrary payoff. This general approach extends the special cases considered in the literature concerned primarily with computing the prices of American puts under transaction costs by relaxing any restrictions on the form of the payoff, the magnitude of the transaction costs or the discrete market model itself. The largely unexplored case of pricing, hedging and stopping for the American option buyer under transaction costs is also covered. The pricing algorithms are computationally efficient, growing only polynomially with the number of time steps in a recombinant tree model. The stopping times realising the ask (seller's) and bid (buyer's) option prices can differ from one another. The former is generally a so-called mixed (randomised) stopping time, whereas the latter is always a pure (ordinary) stopping time.

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Cited in

(17)

• American and Bermudan options in currency markets with proportional transaction costs
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• American options with gradual exercise under proportional transaction costs
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• Options under proportional transaction costs: An algorithmic approach to pricing and hedging
• Optimal exercise of American puts with transaction costs under utility maximization
• Optimal discrete hedging of American options using an integrated approach to options with complex embedded decisions
• Pricing of the American option in discrete time under proportional transaction costs
• Game options with gradual exercise and cancellation under proportional transaction costs
• An algorithm for calculating the set of superhedging portfolios in markets with transaction costs
• Hedging of game options in discrete markets with transaction costs
• Dynkin's games and Israeli options
• Hedging of American options under transaction costs
• No-arbitrage and hedging with liquid American options
• Von Neumann–Gale model, market frictions and capital growth
• Randomized stopping times and American option pricing with transaction costs
• Linear vector optimization and European option pricing under proportional transaction costs

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