An example of indifference prices under exponential preferences
The aim herein is to analyze utility-based prices and hedging strategies. The analysis is based on an explicitly solved example of a European claim written on a nontraded asset, in a model where risk preferences are exponential, and the traded and nontraded asset are diffusion processes with, respectively, lognormal and arbitrary dynamics. Our results show that a nonlinear pricing rule emerges with certainty equivalent characteristics, yielding the price as a nonlinear expectation of the derivative’s payoff under the appropriate pricing measure. The latter is a martingale measure that minimizes its relative to the historical measure entropy. Copyright Springer-Verlag Berlin/Heidelberg 2004
Volume (Year): 8 (2004)
Issue (Month): 2 (05)
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