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Dry markets and superreplication bounds of American derivatives

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  • Joao Amaro de Matos
  • Ana Lacerda

Abstract

This 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.

Suggested Citation

  • Joao Amaro de Matos & Ana Lacerda, 2004. "Dry markets and superreplication bounds of American derivatives," Nova SBE Working Paper Series wp461, Universidade Nova de Lisboa, Nova School of Business and Economics.
    • Handle: RePEc:unl:unlfep:wp461
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    References listed on IDEAS

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    More about this item

    Keywords

    American derivatives; pricing; incomplete markets; dry markets; superreplication; randomized stopping times; strong duality;
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