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Pricing dynamic binary variables and their derivatives

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  • David G. Luenberger

Abstract

Many important assets or business ventures have cash flows that are not derivatives of a market security but are nevertheless dependent on some variable that is correlated with market prices. This includes many real option projects. This paper presents a methodology using a binary framework for pricing such assets by projection onto the market space. Under certain conditions, the result has the property that, given this price process, no risk-averse investor would choose to invest in this asset either long or short.

Suggested Citation

  • David G. Luenberger, 2012. "Pricing dynamic binary variables and their derivatives," Quantitative Finance, Taylor & Francis Journals, vol. 12(3), pages 451-464, April.
    • Handle: RePEc:taf:quantf:v:12:y:2012:i:3:p:451-464
    DOI: 10.1080/14697688.2011.584893
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    References listed on IDEAS

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