On option pricing in illiquid markets with jumps

DOI10.1155/2013/567071MaRDI QIDQ2449007zbMATH OpenOpenAlexWikidataFDO

Authors Youssef El-Khatib, Abdulnasser Hatemi-J

Publication date 6 May 2014

Published in ISRN Mathematical Analysis (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1304.4690

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20)

Abstract: One of the shortcomings of the Black and Scholes model on option pricing is the assumption that trading of the underlying asset does not affect the price of that asset. This assumption can be fulfilled only in perfectly liquid markets. Since most markets are illquid, this assumption might be too restrictive. Thus, taking into account the price impact in option pricing is an important issue. This issue has been dealt with, to some extent, for illiquid markets by assuming a continuous process, mainly based on the Brownian motion. However, the recent financial crisis and its effects on the global stock markets have propagated the urgent need for more realistic models where the stochastic process describing the price trajectories involves random jumps. Nonetheless, works related to markets with jumps are scant compared to the continuous ones. In addition, these previous studies do not deal with illiquid markets. The contribution of this paper is to tackle the pricing problem for options in illiquid markets with jumps as well as the hedging strategy within this context, which is the first of its kind to the best knowledge.

Review text

Summary: One of the shortcomings of the Black-Scholes model on option pricing is the assumption that trading of the underlying asset does not affect the price of that asset. This assumption can be fulfilled only in perfectly liquid markets. Since most markets are illiquid, this assumption might be too restrictive. Thus, taking into account the price impact on option pricing is an important issue. This issue has been dealt with, to some extent, for illiquid markets by assuming a continuous process, mainly based on the Brownian motion. However, the recent financial crisis and its effects on the global stock markets have propagated the urgent need for more realistic models where the stochastic process describing the price trajectories involves random jumps. Nonetheless, works related to markets with jumps are scant compared to the continuous ones. In addition, those previous studies do not deal with illiquid markets. The contribution of this paper is to tackle the pricing problem for options in illiquid markets with jumps as well as the hedging strategy within this context, which is the first of its kind to the authors' best knowledge.

Recommendations

• Option pricing in illiquid markets with jumps
• On some option pricing models on illiquid markets
• Option pricing in illiquid markets: a fractional jump-diffusion approach
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Cites work

• Complete markets with discontinuous security price
• Hedging in complete markets driven by normal martingales
• scientific article; zbMATH DE number 45955 (Why is no real title available?)
• Numerical simulations for the pricing of options in jump diffusion markets
• Option pricing when underlying stock returns are discontinuous
• Option pricing with an illiquid underlying asset market
• The pricing of options and corporate liabilities

Cited in

(6)

• The effect of non-ideal market conditions on option pricing
• Option pricing in illiquid markets: a fractional jump-diffusion approach
• On some option pricing models on illiquid markets
• Option pricing in illiquid markets with jumps
• Option pricing with illiquidity during a high volatile period
• Two approaches for option pricing under illiquidity

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