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Derivative Asset Pricing with Transaction Costs: An Extension

Listed author(s):
  • Perrakis, Stylianos
  • Lefoll, Jean

This paper examines the optimal perfect hedging (super-replication) of an option by a cash-plus-riskless asset portfolio within the context of the binomial model. The cases discussed here were not covered by the earlier studies of Boyle and Vorst (1992) and Bensaid, Lesne, Pages and Scheinkman (1992). It is argued that these cases are empirically important, and that there is some indication that they are encountered very often in practice in the Swiss options market. A new algorithm is developed to compute the option price lower bound (bid price) for such cases. It is then shown that, for most such cases, the portfolio hedging the short call when replication is not optimal coincides with the Merton (1973) lower bound. Citation Copyright 1997 by Kluwer Academic Publishers.

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Article provided by Springer & Society for Computational Economics in its journal Computational Economics.

Volume (Year): 10 (1997)
Issue (Month): 4 (November)
Pages: 359-376

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Handle: RePEc:kap:compec:v:10:y:1997:i:4:p:359-76
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