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Option Pricing in an Oligopolistic Setting

Listed author(s):
  • Villena, Marcelo
  • Villena, Mauricio

Option valuation models are usually based on frictionless markets. This paper extends and complements the literature by developing a model of option pricing in which the derivative and/or the underlying asset have an oligopolistic market structure, which produces an expected return on these assets that exceeds (or goes below) their fundamental value, and hence affects the option valuation. Our formulation begins modeling a capital asset pricing model that takes into account an oligopolistic setting, and hence the standard option pricing formula is derived, but this time considering the level of market power into the model. Our results show that higher levels of market power will lower the required expected return, in comparison to the perfectly competitive CAPM model. Similarly, simulations show that higher levels of market power in the derivative markets tend to increase the call option values in comparison to those values given by the standard Black and Scholes formulation, while the impact of market power in the underlying asset market tends to lower the option price.

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File URL: https://mpra.ub.uni-muenchen.de/57978/1/MPRA_paper_57978.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 57978.

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Date of creation: 01 Mar 2011
Date of revision: 16 Aug 2014
Handle: RePEc:pra:mprapa:57978
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  1. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, 09.
  2. Acharya, Viral V. & Pedersen, Lasse Heje, 2005. "Asset pricing with liquidity risk," Journal of Financial Economics, Elsevier, vol. 77(2), pages 375-410, August.
  3. John Lintner, 1965. "Security Prices, Risk, And Maximal Gains From Diversification," Journal of Finance, American Finance Association, vol. 20(4), pages 587-615, December.
  4. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters, in: Theory Of Valuation, chapter 8, pages 229-288 World Scientific Publishing Co. Pte. Ltd..
  5. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
  6. Figlewski, Stephen, 1989. " Options Arbitrage in Imperfect Markets," Journal of Finance, American Finance Association, vol. 44(5), pages 1289-1311, December.
  7. Fama, Eugene F. & French, Kenneth R., 2012. "Size, value, and momentum in international stock returns," Journal of Financial Economics, Elsevier, vol. 105(3), pages 457-472.
  8. Husmann, Sven & Todorova, Neda, 2011. "CAPM option pricing," Finance Research Letters, Elsevier, vol. 8(4), pages 213-219.
  9. 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.
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