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Valuation of exotic options under shortselling constraints

  • Uwe Wystup

    ()

    (Commerzbank Treasury and Financial Products, Neue Mainzer Strasse 32-36, 60261 Frankfurtam Main, Germany Manuscript)

  • Uwe Schmock

    ()

    (Department Mathematik, ETH Zentrum, CH-8092 Z├╝rich, Switzerland)

  • Steven E. Shreve

    ()

    (Department of Mathematical Sciences, Carnegie Mellon University, Pittsburgh, PA 15213, USA)

Registered author(s):

    Options with discontinuous payoffs are generally traded above their theoretical Black-Scholes prices because of the hedging difficulties created by their large delta and gamma values. A theoretical method for pricing these options is to constrain the hedging portfolio and incorporate this constraint into the pricing by computing the smallest initial capital which permits super-replication of the option. We develop this idea for exotic options, in which case the pricing problem becomes one of stochastic control. Our motivating example is a call which knocks out in the money, and explicit formulas for this and other instruments are provided.

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    Article provided by Springer in its journal Finance and Stochastics.

    Volume (Year): 6 (2002)
    Issue (Month): 2 ()
    Pages: 143-172

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    Handle: RePEc:spr:finsto:v:6:y:2002:i:2:p:143-172
    Note: received: January 2000; final version received: February 2001
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