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Kelly Trading and Option Pricing

Author

Listed:
  • Bermin, Hans-Peter

    (Knut Wicksell Centre for Financial Studies, Lund University)

  • Holm, Magnus

    (Hilbert Capital)

Abstract

In this paper we show that a Kelly trader is indifferent to trade the derivative if and only if the no-arbitrage price is uniquely given by the minimal martingale measure no-arbitrage price, thus providing a natural selection mechanism for option pricing in incomplete markets. We also show that the unique Kelly indifference price results in market equilibrium, in the sense that no Kelly trader can improve the magnitude of his instantaneous Sharpe ratio, by trading the derivative, given the actions of the other market participants.

Suggested Citation

  • Bermin, Hans-Peter & Holm, Magnus, 2019. "Kelly Trading and Option Pricing," Knut Wicksell Working Paper Series 2019/3, Lund University, Knut Wicksell Centre for Financial Studies.
    • Handle: RePEc:hhs:luwick:2019_003
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    More about this item

    Keywords

    Option pricing; Incomplete markets; Hansen-Jagannathan bound; Minimal martingale measure; Kelly Indifference price; Kelly Equilibrium;
    All these keywords.

    JEL classification:

    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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