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52
Pricing and Hedging in Incomplete Markets
 Journal of Financial Economics
, 2001
"... We present a new approach for positioning, pricing, and hedging in incomplete markets that bridges standard arbitrage pricing and expected utility maximization. Our approach for determining whether an investor should undertake a particular position involves specifying a set of probability measures a ..."
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Cited by 54 (6 self)
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We present a new approach for positioning, pricing, and hedging in incomplete markets that bridges standard arbitrage pricing and expected utility maximization. Our approach for determining whether an investor should undertake a particular position involves specifying a set of probability measures and associated °oors which expected payo®s must exceed in order for the investor to consider the hedged and ¯nanced investment to be acceptable. By assuming that the liquid assets are priced so that each portfolio of assets has negative expected return under at least one measure, we derive a counterpart to the ¯rst fundamental theorem of asset pricing. We also derive a counterPricing and Hedging in Incomplete Markets 2 part to the second fundamental theorem, which leads to unique derivative security pricing and hedging even though markets are incomplete. For products that are not spanned by the liquid assets of the economy, we show how our methodology provides more realistic bidask spreads.
A ClosedForm GARCH Option Pricing Model
, 1999
"... This paper develops a closedform option pricing formula for a spot asset whose variance follows a GARCH process. The model allows for correlation between returns of the spot asset and variance and also admits multiple lags in the dynamics of the GARCH process. The singlefactor (onelag) version of ..."
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Cited by 33 (2 self)
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This paper develops a closedform option pricing formula for a spot asset whose variance follows a GARCH process. The model allows for correlation between returns of the spot asset and variance and also admits multiple lags in the dynamics of the GARCH process. The singlefactor (onelag) version of this model contains Heston’s (1993) stochastic volatility model as a diffusion limit and therefore unifies the discretetime GARCH and continuoustime stochastic volatility literature of option pricing. The new model provides the first readily computed option formula for a random volatility model in which current volatility is easily estimated from historical asset prices observed at discrete intervals. Empirical analysis on S&P 500 index options shows the singlefactor version of the GARCH model to be a substantial improvement over the BlackScholes (1973) model. The GARCH model continues to substantially outperform the BlackScholes model even when the BlackScholes model is updated every period and uses implied volatilities from option prices, while the parameters of the GARCH model are held constant and volatility is filtered from the history of asset prices. The improvement is due largely to the ability of the GARCH model to describe the correlation of volatility with spot returns. This allows the GARCH model to capture strikeprice biases in the BlackScholes model that give rise to the skew in implied volatilities in the index options market.
Gain, Loss and Asset Pricing
, 1996
"... In this paper we develop an approach to asset pricing in incomplete markets that gives the modeller the flexibility to control the tradeoff between the precision of equilibrium models and the credibility of noarbitrage methods. We rule out the existence of investment opportunities that are very att ..."
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Cited by 13 (0 self)
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In this paper we develop an approach to asset pricing in incomplete markets that gives the modeller the flexibility to control the tradeoff between the precision of equilibrium models and the credibility of noarbitrage methods. We rule out the existence of investment opportunities that are very attractive to a benchmark investor. The key feature of our approach is the measure of attractiveness employed: the gainloss ratio. The gain (loss) of a portfolio is the expectation, under a benchmark riskadjusted probability measure, of the positive (negative) part of the portfolio's excess payoff. The benchmark riskadjusted probability measure incorporates valuable prior information about investor preferences and portfolio holdings. A restriction on the maximum gainloss ratio in the economy has a dual representation in terms of admissible pricing kernels: it is equivalent to a bound on the ratio of extreme deviations from the benchmark pricing kernel. Price bounds are derived by...
When are Options Overpriced? The BlackScholes Model and Alternative Characterisations of the Pricing Kernel”, working paper
, 1999
"... An important determinant of option prices is the elasticity ofthe pricing kernel used to price all claims in the economy. In this paper, we rst show that for a given forward price of the underlying asset, option prices are higher when the elasticity of the pricing kernel is declining than when it is ..."
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Cited by 10 (1 self)
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An important determinant of option prices is the elasticity ofthe pricing kernel used to price all claims in the economy. In this paper, we rst show that for a given forward price of the underlying asset, option prices are higher when the elasticity of the pricing kernel is declining than when it is constant. We then investigate the implications of the elasticity of the pricing kernel for the stochastic process followed by the underlying asset. Given that the underlying information process follows a geometric Brownian motion, we demonstrate that constant elasticity of the pricing kernel is equivalent to a Brownian motion for the forward price of the underlying asset, so that the BlackScholes formula correctly prices options on the asset. In contrast, declining elasticity implies that the forward price process is no longer a Brownian motion: it has higher volatility and exhibits autocorrelation. In this case, the BlackScholes formula underprices all options. 2 1
Buyprice English auction
 Journal of Economic Theory
, 2006
"... In English auctions, introducing a buy price, i.e., the seller’s maximum price bid at which any bidder at any time can immediately win the auction, allows the seller to gain higher expected utility than that in a traditional auction when either the seller or the buyers are riskaverse. If the seller ..."
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Cited by 10 (0 self)
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In English auctions, introducing a buy price, i.e., the seller’s maximum price bid at which any bidder at any time can immediately win the auction, allows the seller to gain higher expected utility than that in a traditional auction when either the seller or the buyers are riskaverse. If the seller sets the buy price high enough, the buyprice English auction is efficient and guarantees the highest bidder wins. Under this condition, the expected utilities of uniformly riskaverse buyers with CARA utilities remain the same as in a traditional auction, and the buyprice and traditional auctions are revenue equivalent when both the seller and the buyers are risk neutral. A bidder with a valuation above the buy price follows one of three possible pure strategies: If his valuation is very high, he would use the buy price unconditionally without trying to observe other bidders; If his valuation is relatively high, he would use the buy price on the condition that there exists another competing bidder; Otherwise, he would use the buy price when the current high bid reaches a threshold level between the reserve and the buy price. I.
Option Valuation with CoIntegrated Asset Prices
 Journal of Economic Dynamics and Control
, 2001
"... Many financial data series are found to be cointegrated. The implications of cointegration on option valuation are studied in this article, as we develop the option valuation theory for cointegrated price systems. We also examine the diffusion limit of the system and numerically demonstrate the ..."
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Cited by 9 (0 self)
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Many financial data series are found to be cointegrated. The implications of cointegration on option valuation are studied in this article, as we develop the option valuation theory for cointegrated price systems. We also examine the diffusion limit of the system and numerically demonstrate the cointegration effect using spread options.
The Valuation of American Options with Stochastic Interest Rates: A Generalization of the GeskeJohnson Technique
 Journal of Finance
, 1997
"... The GeskeJohnson approach provides an e cient and intuitively appealing technique for the valuation and hedging of Americanstyle contingent claims. Here, we generalize their approach toastochasticinterestrate economy. The method is implemented using options exercisable on one of a nite number of ..."
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Cited by 8 (5 self)
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The GeskeJohnson approach provides an e cient and intuitively appealing technique for the valuation and hedging of Americanstyle contingent claims. Here, we generalize their approach toastochasticinterestrate economy. The method is implemented using options exercisable on one of a nite number of dates. We illustrate how the value of an Americanstyle option increases with interestrate volatility. The magnitude of this e ect depends on the extent to which the option is in the money, the volatilities of the underlying asset and the interest rates, as well as the correlation between them. Valuation of American Options with Stochastic Interest Rates 1
Advance pricing of services and other implications of separating purchase and consumption
 Journal of Service Research
, 2000
"... It is important to differentiate between the act of purchasing and the act of consuming. Understanding this separation provides many implications and areas for future research. For example, the separation creates buyer uncertainty about the utility from consumption. Consider buying a ticket for a co ..."
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Cited by 8 (0 self)
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It is important to differentiate between the act of purchasing and the act of consuming. Understanding this separation provides many implications and areas for future research. For example, the separation creates buyer uncertainty about the utility from consumption. Consider buying a ticket for a concert in advance. Here, buyers maybe uncertain about their future state (e.g., health, expected conflicts, mood) at the time of the concert. This article explores the desirability and implications of this separation and the creation of it (which is often a consequence of the service provider's selling strategy). The authors show that service providers can improve profits by advance ticketing, perhaps, to the level of firstdegree price discrimination (although usually there is no loss in aggregate consumer surplus). These profits are possible despite a service provider's
Heterogeneity and Option Pricing
 REVIEW OF DERIVATIVES RESEARCH
"... An economy with agents having constant yet heterogeneous degrees of relative risk aversion prices assets as though there were a single decreasing relative risk aversion “pricing representative ” agent. The pricing kernel has fat tails and option prices do not conform to the BlackScholes formula. ..."
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Cited by 7 (0 self)
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An economy with agents having constant yet heterogeneous degrees of relative risk aversion prices assets as though there were a single decreasing relative risk aversion “pricing representative ” agent. The pricing kernel has fat tails and option prices do not conform to the BlackScholes formula. Implied volatility exhibits a “smile. ” Heterogeneous beliefs about distribution parameters also implies nonlognormal pricing kernels with fatter tails and “overpricing” of outofthemoney options. Heterogeneity as the source of nonstationary pricing fits Rubinstein’s (1994) interpretation of the “overpricing” as an indication of “crashophobia”. Rubinstein’s term suggests that those who hold outofthemoney put options have relatively high risk aversion or relatively high subjective probability assessments of low market outcomes. The essence of this explanation is heterogeneity in investor attitudes towards risks and probability beliefs.