Utility Indifference Pricing in an Incomplete Market Model with Incomplete Information
AbstractIn this article, we consider a derivative pricing model for the stochastic volatility model under an incomplete information. The incomplete information in our works, supposes that the true value of the drift for the stock price process is a random variable, investors only have an information of its distribution. This is more practical financial market than the situation with knowledge of the drift. There are many studies about the dynamic portfolio optimization problem under the incomplete information. In that situation, the corresponding problem becomes a easy to treat by Separating Principle and Bayesian updating formula. We apply these arguments to the utility indifference price approach, and present pricing method taken into account the incomplete information. On the other hand, Sircar and Zariphopoulou (2005) gives bounds and asymptotic approximations for the indifference prices in the stochastic volatility model. In them works, bounds include the drift parameter for the underlying price process. However, in practice, it is able to observe the drift parameter by estimation only. Therefore, it is meaningful to extended to the incomplete information. We derive bounds for the indifference prices using estimated drift, and the relationship between the buyerfs indifference price and the sellerfs one.
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Bibliographic InfoPaper provided by Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP) in its series Discussion Papers in Economics and Business with number 07-46.
Length: 18 pages
Date of creation: Dec 2007
Date of revision:
Incomplete market; Incomplete information; Utility indifference price; Bayesian updating formula; Super/sub solution for PDEs.;
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-01-05 (All new papers)
- NEP-KNM-2008-01-05 (Knowledge Management & Knowledge Economy)
- NEP-UPT-2008-01-05 (Utility Models & Prospect Theory)
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- Gunther Leobacher & Philip Ngare, 2014. "Utility indifference pricing of derivatives written on industrial loss indexes," Papers 1404.0879, arXiv.org.
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