Pricing and Hedging Options
10 Pages Posted: 23 Oct 2017
Date Written: October 21, 2017
A new derivation of the Black Scholes Equation (BSE) based on integral form stochastic calculus is presented. Construction of the BSE solution is based on infinitesimal perfect hedging. The perfect hedging on a finite time interval is a separate problem that does not change option pricing. The cost of hedging does not present an adjustment of the BS pricing. We discuss a more profound alternative approach to option pricing. It defines option price as a settlement between counterparties and in contrast to BS approach presents the market risk of the option premium.
Keywords: Option, pricing, hedging
JEL Classification: G12, G13
Suggested Citation: Suggested Citation