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Good-Deal Option Price Bounds for a Non-Traded Event with Stochastic Return: A Note

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  • Yong-Jin Kim

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    Abstract

    Cochrane and Sa'a-Requejo (2000, Journal of Political Economy) proposed the good-deal price bounds for the European call option on an event that is not a traded asset, but is correlated with a traded asset that can be used as an approximate hedge. One remarkable feature of their model is that the return on an event process explicitly appears in the option price bounds formula, which offered a contrast with the standard option pricing model. We show that the good-deal option price bounds on a non-traded event are obtained as a closed-form formula, when the return on an event is governed by a mean reverting process. Copyright Springer Science+Business Media, Inc. 2004

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    File URL: http://hdl.handle.net/10.1007/s10690-006-9006-9
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    Article provided by Springer & Japanese Association of Financial Economics and Engineering in its journal Asia-Pacific Financial Markets.

    Volume (Year): 11 (2004)
    Issue (Month): 2 (June)
    Pages: 135-141

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    Handle: RePEc:kap:apfinm:v:11:y:2004:i:2:p:135-141
    DOI: 10.1007/s10690-006-9006-9
    Contact details of provider: Web page: http://www.springer.com

    Web page: http://www.jafee.gr.jp/

    Order Information: Web: http://www.springer.com/finance/journal/10690/PS2

    Keywords: good-deal option price bounds; stochastic return; mean reverting process; incomplete market;

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    1. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
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    3. M. Davis, 2001. "Pricing weather derivatives by marginal value," Quantitative Finance, Taylor & Francis Journals, vol. 1(3), pages 305-308, March.
    4. Kothari, S. P. & Shanken, Jay, 1997. "Book-to-market, dividend yield, and expected market returns: A time-series analysis," Journal of Financial Economics, Elsevier, vol. 44(2), pages 169-203, May.
    5. Amin, Kaushik I & Ng, Victor K, 1993. " Option Valuation with Systematic Stochastic Volatility," Journal of Finance, American Finance Association, vol. 48(3), pages 881-910, July.
    6. Turnbull, Stuart M & Milne, Frank, 1991. "A Simple Approach to Interest-Rate Option Pricing," Review of Financial Studies, Society for Financial Studies, vol. 4(1), pages 87-120.
    7. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October.
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