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A Diffusion Approximation to the Markov Chains Model of the Financial Market and the Expected Riskless Profit Under Selling of Call and Put Options

Author

Listed:
  • Nagaev, Alexander V.

    (Faculty of Mathematics and Computer Sciences, Nicolaus Copernicus University)

  • Nagaev, Sergei A.

    (Department of Economics and Finance, Institute for Advanced Studies)

  • Kunst, Robert M.

    (Department of Economics and Finance, Institute for Advanced Studies and Department of Economics, University of Vienna)

Abstract

A discrete time model of financial markets is considered. It is assumed that the stock price evolution is described by a homogeneous Markov chain. In the focus of attention is the expected value of the guaranteed profit of the investor that arises when the jumps of the stock price are bounded. The suggested diffusion approximation for the Markov chain allows establishing a convenient approximate formula for the studied characteristic.

Suggested Citation

  • Nagaev, Alexander V. & Nagaev, Sergei A. & Kunst, Robert M., 2005. "A Diffusion Approximation to the Markov Chains Model of the Financial Market and the Expected Riskless Profit Under Selling of Call and Put Options," Economics Series 165, Institute for Advanced Studies.
  • Handle: RePEc:ihs:ihsesp:165
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    File URL: http://www.ihs.ac.at/publications/eco/es-165.pdf
    File Function: First version, 2005
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    Cited by:

    1. N. Josephy & L. Kimball & A. Nagaev & M. Pasniewski & V. Steblovskaya, 2006. "An Algorithmic Approach to Non-self-financing Hedging in a Discrete-Time Incomplete Market," Papers math/0606471, arXiv.org.

    More about this item

    Keywords

    Ergodic and irreducible Markov chains; Stationary distribution; Local limit theorem; Upper hedge; Upper rational price;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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