Dry Markets and Superreplication Bounds of American Derivatives
AbstractThis paper studies the impact of dry markets for underlying assets on the pricing of American derivatives, using a disrete time framework. Dry markets are characterized by the possibility of non-existence of trading at certain dates. Such non-existence may be deterministic or probabilistic. Using superreplicating strategies, we derive expectation representations for the range of arbitrage-free values of the dervatives. In the probabilistic case, if we consider an enlarged filtration induced by the price process and the market existence process, ordinary stopping times are required. If not, randomized stopping times are required. Several comparisons of the ranges obtained with the two market restrictions are performed. Finally, we conclude that arbitrage arguments are not enough to define the optimal exercise policy.
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Bibliographic InfoPaper provided by Universidade Nova de Lisboa, Faculdade de Economia in its series FEUNL Working Paper Series with number wp461.
Length: 51 pages
Date of creation: 2004
Date of revision:
American derivatives; pricing; incomplete markets; dry markets; superreplication; randomized stopping times; strong duality;
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-12-20 (All new papers)
- NEP-CFN-2005-12-20 (Corporate Finance)
- NEP-FIN-2005-12-20 (Finance)
- NEP-FMK-2005-12-20 (Financial Markets)
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