Download or read book On the Bounds of Option Prices and Embedded Risk Premium Parameters written by Serguey Khovansky and published by . This book was released on 2008 with total page 34 pages. Available in PDF, EPUB and Kindle. Book excerpt: Theoretical no-arbitrage option prices are not unique in incomplete markets. This complication stems from the unknown risk-premium, which plays an important role in the option valuation problem. This paper establishes restrictions on the risk-premium parameters. The major tools of this research are the newly derived implications of the stochastic dominance theory applied to option valuation. The presented theory provides no-dominance bounds for option prices. Since the bounds depend on the objective probability measure they lack many risk-premium traits embedded into the options. In the framework of stochastic volatility model, for example, the bounds are independent of the volatility risk premium. This sets limits on both the option values and its risk-premium. Empirical evidence supports this view. Namely, incorporation of the no-dominance bounds in the option valuation in the stochastic volatility model allows to reduce the discrepancy between the market and theory prices by around 15% for options with short maturities both in-sample and out-of-sample.

Download or read book New Bounds on Real Option Values written by Unyong Pyo and published by . This book was released on 2009 with total page 36 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper constructs narrow bounds around the value of real options embedded in capital budgeting decisions by applying the minimax deviations approach to real options in incomplete markets. While it is straightforward to obtain the unique value of a real option with HARA utility functions, the parameters of risk-aversion are often subject to misspecification and raise concerns for practical uses. Recognizing that investors allow deviation from parameter values related to a benchmark pricing kernel, we derive narrow bounds on a real option price. Comparison with the approaches in the literature clarifies advantages of the minimax bounds: simple, consistent, and efficient.

Download or read book Volatility Risk Premiums Embedded in Individual Equity Options written by Nikunj Kapadia and published by . This book was released on 2003 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: The research indicates that index option prices incorporate a negative volatility risk premium, thus providing a possible explanation of why Black-Scholes implied volatilities of index options on average exceed realized volatilities. This examination of the empirical implication of a market volatility risk premium on 25 individual equity options provides some new insights.While the Black-Scholes implied volatilities from individual equity options are also greater on average than historical return volatilities, the difference between them is much smaller than for the market index. Like index options, individual equity option prices embed a negative market volatility risk premium, although much smaller than for the index option - and idiosyncratic volatility does not appear to be priced.These empirical results provide a potential explanation of why buyers of individual equity options leave less money on the table than buyers of index options.

Download or read book Option Pricing Under Decreasing Absolute Risk Aversion written by Kamlesh Mathur and published by . This book was released on 1999 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: This article establishes bounds on option prices in an economy where the representative investor has non increasing absolute risk aversion. The bounds do not require knowledge of any specific utility parameters, nor do they require specific joint distribution assumptions between the marginal utility of aggregate consumption and the underlying stock price. To drive our results we only require that the expected marginal utility of consumption conditional on the stock price is monotone non increasing in the stock price, and that the marginal distribution of the stock price is given. With this assumption, the lower bound on option prices is given by the solution to a non-linear mathematical program. We identify the general solution of this program. If the underlying process is multinomial, we show that the lower bound is set up as if the representative investor had constant proportional risk aversion. For this case, a risk neutral valuation relationship exists. As a result, the lower bound does not depend on the drift term, nor is it affected by the number of permissible trading periods prior to expiration. Moreover, if the underlying distribution is lognormal, the lower bound is the Black Scholes price. The upper bound on option prices is also identified and its behavior as multiple portfolio opportunities exist is examined.

Download or read book Adjusting Option Pricing Models for Informative Starting Points written by Hammad Siddiqi and published by . This book was released on 2017 with total page 35 pages. Available in PDF, EPUB and Kindle. Book excerpt: In incomplete markets, risk judgments regarding options are necessary as options cannot be replicated by using the underlying stock and the risk-free asset. How are such risk judgments formed? Underlying stock risk is a natural starting point for call option risk as the two assets pay off in the same states, and call option volatility is a scaled-up version of the underlying stock volatility. However, using underlying stock risk as a starting point and attempting to scale-up appropriately exposes investors to anchoring bias, which lowers the risk-premium demanded on a call option. I show that anchoring-influenced option prices always lie within no-arbitrage bounds in incomplete markets. Modified versions of Black-Scholes, Heston, and Bates models are put forward. Modified models show improvements across several dimensions, while capturing several option-return puzzles. Two novel predictions arising from the modification are also empirically supported.

Download or read book Equilibrium Pricing Bounds on Option Prices written by Marie Chazal and published by . This book was released on 2007 with total page 45 pages. Available in PDF, EPUB and Kindle. Book excerpt: We consider the problem of valuing European options in a complete market but with incomplete data. Typically, when the underlying asset dynamics is not specified, the martingale probability measure is unknown. Given a consensus on the actual distribution of the underlying price at maturity, we derive an upper bound on the call option price by putting two kind of restrictions on the pricing probability measure.First, we put a restriction on the second risk-neutral moment of the underlying asset terminal value. Second, from equilibrium pricing arguments one can put a monotonicity restriction on the Radon-Nikodym density of the pricing probability with respect to the true probability measure. This density is restricted to be a nonincreasing function of the underlying price at maturity. The bound appears then as the solution of a constrained optimization problem and we adopt a duality approach to solve it.We obtain a weak sufficient condition for strong duality and existence for the dual problem to hold, for options defined by general payoff functions. Explicit bounds are provided for the call option. Finally, we provide a numerical example.

Download or read book Improved Lower Bounds of Call Options Written on Defaultable Assets written by Greg Orosi and published by . This book was released on 2015 with total page 6 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper provides an improved model-independent lower bound of European call options written on defaultable assets. Based on static arbitrage arguments, improved lower bounds are established, which also depend on the probability of option implied default. The results are also extended to dividend paying stocks. Moreover, our findings imply that it is never optimal to exercise certain American call options. Finally, we discuss the implications of our results for constructing an arbitrage-free volatility surface and extracting risk-neutral densities from option prices.

Download or read book Option Pricing Bounds with Standard Risk Aversion Preferences written by A. Basso and published by . This book was released on 2018 with total page 17 pages. Available in PDF, EPUB and Kindle. Book excerpt: For a theoretical valuation of a financial option, various models have been proposed that require specific hypotheses regarding both the stochastic process driving the price behaviour of the underlying security and market efficiency. When some of these assumptions are removed, we obtain an uncertainty interval for the option price. Up to now, the most restrictive intervals for option prices have been obtained using the DARA rule in a state preference approach.Precautionary saving entails the concept of prudence; in particular, decreasing absolute prudence is a necessary and sufficient condition that guarantees that the saving of wealthier people is less sensitive to the risk associated to future incomes. If this condition is coupled with the decreasing absolute risk aversion assumption we obtain standard risk aversion, which guarantees on the one hand that introducing a zero-mean background risk to wealth makes people less willing to accept another independent risk and on the other hand that an increase in the risk of the returns distribution of an asset reduces the demand for this asset.The main idea of this contribution is to apply decreasing absolute prudence and standard risk aversion rules in a state preference context in order to obtain efficient bounds for the value of European-style options portfolio strategies.Lower and upper bounds for the options portfolio value are obtained by solving non linear optimization problems. The numerical experiments carried out show the efficiency of the technique proposed.

Download or read book Informative Starting Points and Option Prices written by Hammad Siddiqi and published by . This book was released on 2017 with total page 34 pages. Available in PDF, EPUB and Kindle. Book excerpt: In incomplete markets, risk judgments regarding options are necessary as options cannot be replicated by using the underlying stock and the risk-free asset. How are such risk judgments formed? Underlying stock risk is a natural starting point for call option risk as the two assets pay off in the same states, and call option volatility is a scaled-up version of the underlying stock volatility. However, using underlying stock risk as a starting point and attempting to scale-up appropriately exposes investors to anchoring bias, which lowers the risk-premium demanded on a call option. I show that anchoring-influenced option prices always lie within no-arbitrage bounds in incomplete markets. Modified versions of Black-Scholes, Heston, and Bates models are put forward. Modified models show improvements across several dimensions, while capturing several option-return puzzles. Two novel predictions arising from the modification are also empirically supported.

Download or read book Option Implied Risk Neutral Distributions and Risk Aversion written by Jens Carsten Jackwerth and published by . This book was released on 2008 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt:

Download or read book Accounting for Risk Hedging and Complex Contracts written by A. Rashad Abdel-Khalik and published by Routledge. This book was released on 2013-10-08 with total page 592 pages. Available in PDF, EPUB and Kindle. Book excerpt: With the exponential growth in financial derivatives, accounting standards setters have had to keep pace and devise new ways of accounting for transactions involving these instruments, especially hedging activities. Accounting for Risk, Hedging and Complex Contracts addresses the essential elements of these developments, exploring accounting as related to today's most relevant topics - risk, hedging, insurance, reinsurance, and more. The book begins by providing a basic foundation by discussing the concepts of risk, risk types and measurement, and risk management. It then introduces readers to the nature and valuation of free standing options, swaps, forward and futures as well as of embedded derivatives. Discussion and illustrations of the cash flow hedge and fair value hedge accounting treatments are offered in both single currency and multiple currency environments, including hedging net investment in foreign operations. The final chapter is devoted to the disclosure of financial instruments and hedging activities. The combination of these topics makes the book a must-have resource and reference in the field. With discussions of the basic tools and instruments, examinations of the related accounting, and case studies to help students apply their knowledge, this book is an essential, self-contained source for upper-level undergraduate and masters accounting students looking develop an understanding of accounting for today’s financial realities.

Download or read book The Equity Risk Premium written by William N. Goetzmann and published by Oxford University Press. This book was released on 2006-11-16 with total page 568 pages. Available in PDF, EPUB and Kindle. Book excerpt: What is the return to investing in the stock market? Can we predict future stock market returns? How have equities performed over the last two centuries? The authors in this volume are among the leading researchers in the study of these questions. This book draws upon their research on the stock market over the past two dozen years. It contains their major research articles on the equity risk premium and new contributions on measuring, forecasting, and timing stock market returns, together with new interpretive essays that explore critical issues and new research on the topic of stock market investing. This book is aimed at all readers interested in understanding the empirical basis for the equity risk premium. Through the analysis and interpretation of two scholars whose research contributions have been key factors in the modern debate over stock market perfomance, this volume engages the reader in many of the key issues of importance to investors. How large is the premium? Is history a reliable guide to predict future equity returns? Does the equity and cash flows of the market? Are global equity markets different from those in the United States? Do emerging markets offer higher or lower equity risk premia? The authors use the historical performance of the world's stock markets to address these issues.

Download or read book International Convergence of Capital Measurement and Capital Standards written by and published by Lulu.com. This book was released on 2004 with total page 294 pages. Available in PDF, EPUB and Kindle. Book excerpt:

Download or read book The Efficient Market Theory and Evidence written by Andrew Ang and published by Now Publishers Inc. This book was released on 2011 with total page 99 pages. Available in PDF, EPUB and Kindle. Book excerpt: The Efficient Market Hypothesis (EMH) asserts that, at all times, the price of a security reflects all available information about its fundamental value. The implication of the EMH for investors is that, to the extent that speculative trading is costly, speculation must be a loser's game. Hence, under the EMH, a passive strategy is bound eventually to beat a strategy that uses active management, where active management is characterized as trading that seeks to exploit mispriced assets relative to a risk-adjusted benchmark. The EMH has been refined over the past several decades to reflect the realism of the marketplace, including costly information, transactions costs, financing, agency costs, and other real-world frictions. The most recent expressions of the EMH thus allow a role for arbitrageurs in the market who may profit from their comparative advantages. These advantages may include specialized knowledge, lower trading costs, low management fees or agency costs, and a financing structure that allows the arbitrageur to undertake trades with long verification periods. The actions of these arbitrageurs cause liquid securities markets to be generally fairly efficient with respect to information, despite some notable anomalies.

Download or read book The Journal of Derivatives written by and published by . This book was released on 2001 with total page 708 pages. Available in PDF, EPUB and Kindle. Book excerpt:

Download or read book Working Paper Series written by and published by . This book was released on 1998 with total page 506 pages. Available in PDF, EPUB and Kindle. Book excerpt:

Download or read book Monetary and Financial Statistics Manual and Compilation Guide written by Mr.Jose M Cartas and published by International Monetary Fund. This book was released on 2017-11-09 with total page 450 pages. Available in PDF, EPUB and Kindle. Book excerpt: This edition of Monetary and Financial Statistics Manual and Compilation Guide (Manual) updates and merges into one volume methodological and practical aspects of the compilation process of monetary statistics. The Manual is aimed at compilers and users of monetary data, offering guidance for the collection and analytical presentation of monetary statistics. The Manual includes standardized report forms, providing countries with a tool for compiling and reporting harmonized data for the central bank, other depository corporations, and other financial corporations.