American and exotic options in a market with frictions

Gero Junike*, Argimiro Arratia, Alejandra Cabaña, Wim Schoutens

*Corresponding author for this work

Research output: Contribution to journalArticleResearchpeer-review

1 Citation (Scopus)

Abstract

In a market with frictions, bid and ask prices are described by sublinear pricing functionals, which can be defined recursively using coherent risk measures. We prove the convergence of bid and ask prices for various European and American possible path-dependent options, in particular plain vanilla, Asian, lookback and barrier options in a binomial model with transaction costs. We perform several numerical experiments to confirm the theoretical findings. We apply the results to real market data of American options and compute an implied liquidity to describe the bid–ask spread. This method describes liquidity over time very well, compared to the classical approach of describing bid and ask prices by quoting bid and ask implied volatilities.
Original languageEnglish
Article number1350002
Pages (from-to)179-199
Number of pages21
JournalEuropean Journal of Finance
Volume26
Issue number2-3
DOIs
Publication statusPublished - 2 Apr 2019

Keywords

  • American options
  • barrier options
  • bid–ask spread
  • binomial model
  • Market with frictions
  • RISK MEASURES
  • PRICE FUNCTIONALS
  • CONVERGENCE
  • bid-ask spread

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