When Does Extra Risk Strictly Increase an Option's Value?
It is well known that risk increases the value of options. This paper makes that precise in a new way. The conventional theorem says that the value of an option does not fall if the underlying option becomes riskier in the conventional sense of the mean-preserving spread. This paper uses two new definitions of "riskier" to show that the value of an option strictly increases (a) if the underlying asset becomes "pointwise riskier," and (b) only if the underlying asset becomes "extremum riskier."
|Date of creation:||2004|
|Publication status:||Forthcoming in Review of Financial Studies|
|Contact details of provider:|| Postal: 1309 East Tenth Street, Room 451, Bloomington, IN 47405-1701|
Web page: http://kelley.iu.edu/bepp/
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World Scientific Publishing Co. Pte. Ltd..
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- Merton, Robert C., 1976. "Option pricing when underlying stock returns are discontinuous," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 125-144.
- Merton, Robert C., 1975. "Option pricing when underlying stock returns are discontinuous," Working papers 787-75., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June. Full references (including those not matched with items on IDEAS)
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