Local martingales, bubbles and option prices
In this article we are interested in option pricing in markets with bubbles. A bubble is defined to be a price process which, when discounted, is a local martingale under the risk-neutral measure but not a martingale. We give examples of bubbles both where volatility increases with the price level, and where the bubble is the result of a feedback mechanism. In a market with a bubble many standard results from the folklore become false. Put-call parity fails, the price of an American call exceeds that of a European call and call prices are no longer increasing in maturity (for a fixed strike). We show how these results must be modified in the presence of a bubble. It turns out that the option value depends critically on the definition of admissible strategy, and that the standard mathematical definition may not be consistent with the definitions used for trading. Copyright Springer-Verlag Berlin/Heidelberg 2005
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Volume (Year): 9 (2005)
Issue (Month): 4 (October)
|Contact details of provider:|| Web page: http://www.springerlink.com/content/101164/|
|Order Information:||Web: http://link.springer.de/orders.htm|
When requesting a correction, please mention this item's handle: RePEc:spr:finsto:v:9:y:2005:i:4:p:477-492. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Guenther Eichhorn)or (Christopher F Baum)
If references are entirely missing, you can add them using this form.